#225: The non-obvious trade on AI
When it comes to Artificial Intelligence, we often think of the obvious winners like Nvidia, Microsoft (OpenAI), Alphabet (Google), etc.
Utilities (yes, electricity) stocks are traditionally considered "defensive" — with the current AI boom, that may no longer be the case
How XLU traditionally moves
Above are the top 10 holdings that make up XLU, the utilities sector ETF managed by State Street.
These companies all engage in energy production and distribution, each varying in their mix of energy sources, geographic operational areas, and regulatory environments, reflecting distinct strategies and market adaptations.
Here are prevailing price movements XLU traditionally exhibits:
It is low beta — Given the industry is one of the more regulated and growth-limited ones, despite the stable profits and relatively high dividend payouts, XLU tends to underperform the broader market index (i.e. S&P500).
It is interest rate sensitive — Given the high dividend payout ratio, XLU often, in the medium-term, moves in tandem with benchmark bond yields.
An interesting past three months
The past months have been very different
XLU rose 15.9%, outperforming the broader index (SPY) by 12%+
While the utilities sector ranked last among the 11 sectors in 2023, XLU is #1 sector in price growth over the past three months.
Why & Is this sustainable?
The main driver for this XLU rally is the very clear fact that demand for electricity will see a significant boost with the widespread adoption of generative AI. AI requires substantial computing power, significantly increasing load on data centers and power grids.
Creating this very much needed supply takes a long time, however — power plants take years to get approved and built, and it will likely take a while for us to see actual translation into earnings results.
15% rally in an ETF that represents an entire sector in a short three-month timeframe (when the overall market only rose 3%) can be a sign that XLU is currently in an extreme "overbought" territory and that XLU may be susceptible to a short-term pullback.
💡 Ape of Omaha’s Takeaway:
XLU will likely rally in the coming years at a pace that is traditionally unusual for the sector.
Whether there is a pullback ahead or not, regularly buying into this ETF (to dollar-cost average) is worth including in one’s portfolio, as it will capitalize on the growing demand for electricity driven by advancements in technology like generative AI.
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