The surprising reason why utilities stocks have suddenly transformed into the hottest sector on Wall Street

By Joseph Adinolfi

It has little to do with the economy - and a lot to do with who will benefit from the rise of artificial intelligence

Utilities stocks have staged a remarkable turnaround over the past few months. The reason behind it may come as a surprise.

The sector XX:SP500.55 finished at a fresh 52-week high on Thursday - following an 8.5% gain since the start of April that has transformed it into the top-performing S&P 500 SPX sector of the second quarter, and the third-best performing sector this year to date. Utilities have outperformed the large-cap benchmark index at large by 3% in 2024, according to FactSet data, with the sector up 19% from its mid-February low.

And the pace of the sector's gains has picked up over the past month. As of Thursday's close, utilities had risen during 15 of the past 17 trading days, the most during a 17-day period since February 2020, Dow Jones Market Data show.

That is a far cry from 2023, when the sector ranked last among the 11 comprising the S&P 500.

At first blush, seeing utilities outperform like this might make some investors nervous. Typically, when defensive sectors like utilities are in the lead, the rest of the market isn't doing so well.

Considering that another defensive sector, consumer staples, also hit a 52-week high on Thursday, it is understandable that investors might question whether the turbulence that gripped markets in April has truly passed, or if the stock market might be poised to resume last month's slide, said Paul Hickey, an analyst at Bespoke Investment Group.

A recent stretch of mixed economic data that has raised concerns about a slide into stagflation has helped amplify those fears.

But both Hickey and a portfolio manager who spoke with MarketWatch on Thursday noted that the reality of what is driving the utilities rally has little to do with the health of the overall economy.

Instead, the sector has emerged as the latest potential beneficiary of the artificial-intelligence craze, which has driven massive gains for chip stocks like Nvidia Corp. (NVDA) and other companies like Microsoft Corp. (MSFT) that are believed to be at the cutting edge of the new technology.

The first-quarter earnings season has shown that companies like Microsoft and Amazon.com Inc. (AMZN) are dedicating more financial resources to buying next-generation chips and building data centers to power the artificial-intelligence push.

Those data centers will require more power, and investors believe that utilities stocks - particularly those focused on clean energy and nuclear power - will benefit from this expected surge in demand.

"You've got traders jumping into utilities on this," said Alan Rosenfield, managing director and portfolio manager at Harmony Asset Management.

Among utilities stocks, Vistra Corp. (VST), Constellation Energy Corp. (CEG) and NRG Energy Inc. (NRG) - all of which have exposure to nuclear power - are the three top-performing stocks in the sector in 2024. They have all booked staggering gains this year, with Vistra up more than 144%, Constellation up more than 84% and NRG Energy up nearly 58%.

Hickey told MarketWatch that the rise in utilities stocks is just another aspect of the sector rotation that has been going on all year, as investors hunt for value in corners of the market that have underperformed the leading technology names.

"I don't think the fact that utilities are rallying is a big warning sign for the market," Hickey said. "It's a rotation - some investors are looking for the play on AI and the power needs required."

In the past, both the utilities sector and the broader S&P 500 have continued to climb after utilities stocks hit their first 52-week high in more than a year, which happened earlier this week, according to an analysis of historical data by Bespoke.

During the six months that followed, the S&P 500 has on average gained 9.5%, while utilities have tacked on another 6.3%.

However, there are signs that the sector is looking vulnerable to a pullback following its latest spring higher. According to Bespoke, a majority of utilities stocks are trading in "extreme overbought" territory.

See: This time surging utility stocks are a danger to themselves but not the wider market

The Utilities Select Sector SPDR Fund XLU is up 13.6% in 2024 as of Thursday's close, when it finished at $71.34 a share. By comparison, the S&P 500 has gained 9.3% this year, excluding dividends, to close Thursday at 5,214 points, according to FactSet data.

Utilities stocks have also outperformed the Nasdaq Composite COMP and Dow Jones Industrial Average DJIA. The Nasdaq has gained 8.9% in 2024 so far to finish Thursday at 16,346 points, while the Dow has gained 1,698.22 points, or 4.5%, to close at 39,387 on Thursday.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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05-10-24 0826ET

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