Utilities Stocks Have an AI Edge Over Bonds
Electric-utility stocks around the globe have been poor performers this year. Both the Dow Jones Utility Average and iShares Global Utilities exchange-traded fund are flat this year, missing the broader market rally.
For many investors, utilities are nothing more than bond proxies, stocks to own because of their high dividend yields. With the U.S. 10-year Treasury note now yielding just north of 4.4%, some would argue that there’s no need to own utilities when you can buy bonds, instead.
But growing hopes that inflation pressures are close to peaking could push interest rates and bond yields lower in the U.S. and Europe at some point later this year…and that might brighten the outlook for utilities once more.
“The utilities sector’s poor performance has likely gone too far. If yields
fall, as is our core view, that should help the sector,” equity strategy analysts for J.P. Morgan Securities in London wrote in a report Monday.
Utility stocks pay rich dividends, and the average yield for the 15 stocks in the Dow Jones Utility Average is nearly 3.7%. If the Federal Reserve begins cutting interest rates later this year (Fed-funds futures are pricing in an almost 70% chance of easing in late July, and nearly 90% probability of a rate cut in September) then investors seeking more income will pour into companies and sectors that pay higher yields.
“Defensive, income-oriented sectors…should respond favorably to a less restrictive Federal Reserve (Fed) interest-rate stance,” U.S. Bank Wealth Management chief equity strategist Terry Sandven wrote in a report last week, noting that many utilities and other high-yielding sectors such as real-estate investment trusts and consumer-staples firms “lagged during last year’s rising interest-rate environment.”
Add in the fact that analysts are expecting steady rates of annual earnings growth in the mid-single digits this year and for the next few years for top utilities such as Duke Energy, FirstEnergy, and Exelon, and potential total returns approach 10%. That would likely outperform Treasury bonds and other fixed income investments, especially if the 10-year yield is close to peaking.
Also, some utility stocks are performing more like high-momentum tech stocks, thanks to the artificial-intelligence boom, since AI data centers need a lot of energy.
“We would consider adding exposure to utility stocks as the second derivative of AI, since AI development is expected to drive increasing demands for power,” Richard Saperstein, chief investment officer with Treasury Partners, an investment firm with $9 billion in assets under management, wrote in a report Monday.
AI has already given a particularly big boost to utilities in the nuclear power sector. Constellation Energy stock, for example, is up more than 65% this year—the third-best performer in the S&P 500 for 2024, trailing only shares of AI darlings Super Micro Computer and Nvidia.
Nobody is going to start confusing sleepy utility stocks for the Magnificent Seven of the Nasdaq anytime soon. But there still could be some more upside for the sector ahead thanks to AI and big dividends.