In recent quarters, inflation has prompted companies to focus on cost-cutting measures to improve their profitability. Artificial Intelligence (AI) technology offers new avenues for enhancing productivity, a trend that is expected to benefit a broad range of industries. The transition towards efficiency-driven growth is seen as a bullish indicator for the market, particularly for sectors that have been overlooked in the recent tech-centric investment environment.
Investors are captivated by the transformative potential of Artificial Intelligence, but focusing solely on large tech companies might lead them to overlook significant opportunities in other sectors like energy & utilities. As AI technology advances, its impact is expected to extend beyond the realm of semiconductor and software stocks to areas which require substantial electricity demand, such as data centers.
AI and the Energy Sector
The integration of AI technology necessitates substantial energy consumption, particularly in data centers, where Artificial Intelligence programs are trained and hosted. Data centers linked to Artificial Intelligence are facilities optimised for the high computational demands of AI applications. They host powerful servers and storage systems, enabling the training and operation of AI models.
Historically, sectors such as energy and utilities have benefited from increased energy use, a trend that Artificial Intelligence is likely to amplify. The Biden administration’s emphasis on bolstering U.S. nuclear production alongside solar and wind energy underscores the growing importance of these sectors. A diversified energy grid that includes nuclear, solar, and wind energy can enhance the resilience and reliability of the power supply. Nuclear energy provides a consistent output, which can balance the variability of renewable sources, ensuring a stable electricity supply even during periods of low solar and wind production.
Modernising the electrical grid with smart technologies and energy storage solutions is critical for supporting the robust, reliable, and efficient power needs of data centers involved in Artificial intelligencedevelopment. This modernisation not only enhances the resilience and sustainability of power supply but also enables cost savings, scalability, and security, which are essential for the continuous and effective operation of AI-driven data centers.
The performance of energy and utilities this year, with gains of 10% and 9% respectively, reflects their potential as viable investment alternatives amidst rising electricity demands driven by Artificial Intelligence.
Energy Infrastructure and Investment
Years of underinvestment in energy infrastructure have created capacity constraints that could pose significant challenges. The International Energy Agency (IEA) projects a near doubling of global power demand from data centers and cryptocurrency by 2026. This increased demand underscores the necessity for substantial investments in energy infrastructure to avoid bottlenecks and meet the rising needs of AI data centers.
The U.S. and European electricity grids are already operating near capacity, with the U.S. grid reaching 94% capacity last year. The rising demand for Artificial intelligence and traditional data centers is likely to exacerbate these constraints. Investment in energy infrastructure is critical to ensure that the power supply can meet the escalating demands driven by AI advancements. To underscore the point, tech-focused Ireland is expected to see a third of its electricity demand coming from data centers by 2026.
Comparing Tech and Energy Valuations
Large growth stocks outperformed their value counterparts with a 20% gain in 2024, mostly due to huge rallies in a handful of megacap tech companies, compared to just 8.5% for value stocks.
The tech sector’s high valuations and sensitivity to inflation make it vulnerable in a commodity-driven inflationary environment. Although tech stocks lead in AI, they are highly exposed to inflation due to their long-duration cash flows, making them vulnerable to rising interest rates. In 2022, tech was the worst-performing US sector against the S&P 500 as inflation surged and the Fed raised rates.
Conversely, inflationary periods, especially those driven by commodities, favour low-duration energy stocks, which outperformed all other sectors in 2022. Utilities also performed well and are now perceived to be better positioned to benefit from increasing power demand as a low-duration sector. Given that we have no clear evidence whether Central Banks’ goal to tame inflation has been achieved or not, tech stocks remain vulnerable to inflation risks while energy and utility stocks may stand to benefit.
Given that the technology sector continues to embed the highest premium versus the S&P 500 Index, the sector looks quite rich relative to the sector’s long-term median Price to Earnings. Despite the structural tailwinds the tech sector faces due to the Artificial Intelligence theme, at current multiples if earnings disappoint, or rather do not meet or exceed investors’ expectations, specific technological companies may face considerable downside.
In contrast, the energy and utility sectors trade at a discount relative to the market, presenting a compelling investment opportunity. These sectors stand to benefit from rising commodity prices and increased power demand, offering an attractive risk/return profile. Investors may find value in these sectors, capitalising on the early stages of the Artificial Intelligence revolution while avoiding the high valuations and volatility characteristic of tech stocks.
Conclusion
While it is uncertain that utility and energy companies will outperform growth companies in the short to medium term, the recent indiscriminate surge in tech companies suggests that all players will benefit equally from AI advancements, when the reality will likely be quite different. As the tech sector continues to develop, it’s essential to recognise the potential winners and losers within this space.
Although the tech sector is positioned to benefit from first order effects from Artificial Intelligence implementation, in the long run, other sectors will also benefit and present compelling investment opportunities. A balanced portfolio should include specific high-growth tech companies as well as companies offering stability and resilience. Investors should diversify their portfolios, considering utility and energy companies, which will gain from second order effects of the AI revolution.
By diversifying across tech and value stocks, investors can better navigate the complexities of the AI boom. This strategy ensures more balanced portfolio growth and mitigates risks associated with high valuations and volatility in the tech sector. Including energy and utility companies in an investment portfolio may provide a hedge against potential downturns in the tech sector while taking advantage of the increasing demand for energy driven by AI advancements.
In summary, adopting a diversified investment approach that spans both tech and value stocks allows investors to capitalise on the multifaceted impacts of Artificial Intelligence technology, leading to a more stable and resilient portfolio.
Written by
Mark Muscat, M.Sc. in Banking and Finance
Assistant Portfolio Manager, ReAPS Asset Management Ltd
The information contained in this article represents the opinion of the contributor and is solely provided for information purposes. It is not to be interpreted as investment advice, or to be used or considered as an offer, or a solicitation to sell / buy or subscribe for any financial instruments nor to constitute any advice or recommendation with respect to such financial instruments. This article was issued by ReAPS Asset Management Limited, a subsidiary of APS Bank plc. ReAPS Asset Management Limited (C77747) with registered address at APS Centre, Tower Street, Birkirkara BKR 4012 is regulated by the Malta Financial Services Authority as a UCITS Management Company and to carry out Investment Services activities under the Investment Services Act 1994 and is registered as an Investment Manager under the Retirement Pensions Act.
