Prediction: This unexpected category will end 2024 as the top sector of the stock market

The stock market has soared this year, led by big tech stocks like Nvidia, Meta platformand Broadcom. But if you scratch the surface, you find a surprising group of stocks that are even hotter than tech: utilities. That is correct.

Let’s dig into what’s happening to boost those stocks’ performance and why the utilities sector could end the year as the market’s best performing sector.

Image source: Getty Images.

How utilities have fared so far this year

As of this writing, S&P 500 has generated a total return of 17.8% year to date. utilities sector, measured by Utilities Select Sector SPDR ETFs (XLU -0.79%), generated a total return of 20.7%. This is better than any other sector, including the technology sector, as measured by Technology Select Sector SPDR ETF.

XLU Total Return Level data by YCharts.

But Why is it outdated? The answer lies in several optimistic trends.

First, the utilities sector is gaining a tailwind from the growing use of artificial intelligence (AI). In short, AI applications require power — extremely power hungry. Some reports estimate that AI applications currently consume about 8 terawatt-hours (TWh) of energy. That’s about it equal to the amount of energy produced by the state of Rhode Island in 2022.

MoreAI power consumption it is to be expected to explode over the next few years. Some predict it could reach 52 TWh by 2026 — similar to the entire annual energy production of Massachusetts. By 2030, it might really explode — requires more power than whole The 2022 production is generated by Florida, California and New York.

In other words, there is an enormous demand for additional energy production due to the skyrocketing demand for AI applications. Obvious, this could be an advantage for utility providers.

However, there are some caveats. First, many utilities are highly regulated because of their monopolistic nature, which means it is difficult for them to raise prices. Second, it is time consuming and costly to add new power plants. So even with the added demand, utilities will have to spend big on capital expenditures to build or expand their power plants.

Why utilities could end the year as the best performing sector

However, there is more than just AI driving the price of utility stocks. The second factor at play is the cost of borrowing: interest rates.

10 Year Treasury Rate Data by YCharts.

After hitting multi-decade lows, long-term interest rates returned to the upside in 2022 as inflation picked up and the Federal Reserve raised its benchmark rates in an attempt to control it. But inflation has cooled, and now long-term interest rates are falling again as the market eagerly awaits cuts in the federal funds rate.

10 Year Treasury Rate Data by YCharts.

That’s it great news for utility stocks for two reasons:

1. Lower interest rates mean lower borrowing costs. Utilities prefer lower borrowing costs because – as noted – it’s expensive to build new power plants or expand existing ones.
2. Lower interest rates make fixed income securities like bonds less attractive. This may encourage income-seeking investors to shift more of their investments to utility stocks, which generally have solid dividend yields.

Of course, falling long-term interest rates can also signal slower economic growth — or even the possibility of a future recession. However, utility stocks, as a defensive sector, often outperform in recessionary environments.

Bottom line, there are a number of reasons utility stocks have such a bullish 2024, including falling interest rates, rising energy demand and the potential for slower economic growth. Investors who overlooked the sector before may want to give it a second look now.