Why You Should Pass on These New 'AI Stocks'

By Brett Eversole

"The Unlikely Stocks That Became a Hot Bet on AI"...

The Wall Street Journal ran that headline last month. The article described a dull sector that's full of companies most tech and AI investors wouldn't have thought twice about before this year.

Now, everyone is hoping that the stock market's most exciting trend will scoop up its most boring sector: utility stocks.

I'm not sold on this idea. And as I'll explain, you shouldn't be either...

The reason is simple. Regardless of their role in tech, utility stocks have already soared at an extreme rate. And according to history, we should expect a major slowdown in the months ahead...

Why are boring utility stocks suddenly joining the AI mania? It's all about power...

The new AI data centers coming on line will need a lot of electricity. And as the AI industry develops, folks believe we'll see a huge, long-term increase in demand for utilities.

This story makes sense... But that doesn't mean we should expect utility stocks to soar hundreds of percent. For one thing, these are still highly regulated, boring businesses.

What's more, these stocks have already soared much further – and faster – than we typically see. Just look at how utility stocks have performed in recent months, based on the Utilities Select Sector SPDR Fund (XLU)...

Stocks were a darn good investment this spring... But utilities crushed the overall market. The sector recently blew past a 16% return in just three months – more than triple the return of the S&P 500.

It was a huge short-term gain. And by now, utilities are up 18% since late February, versus 6% for the broad market.

Normally, this momentum would be a sign of a powerful uptrend. We'd usually expect these strong returns to continue. But utilities aren't like most other stocks...

To see this, I found the rolling three-month returns for the utilities sector. That allows us to identify any short-term period where utility stocks soar – something that doesn't happen often.

Then, I analyzed what happened after each new case of trailing three-month returns above 15%. Take a look...

Boring or not, utilities have rewarded long-term investors. The sector has produced annual gains of 9.7% since 2003. But you don't want to buy these stocks after they've boomed...

Similar setups led to 0.9% losses in six months and just 1.7% gains over a year. That's a far cry from the sector's impressive buy-and-hold results.

So, even with a tie to the AI boom, utilities can only soar so much. And when you think about it, that makes sense...

These stocks can't rise to the moon. Investors buy them for consistent dividends – not capital gains. Higher returns will push their dividend yields too low for folks to stay interested.

We're at that point right now. The sector pays just a 3% dividend yield, thanks to its big run-up. That's low compared with history... And it's even worse when you can earn 5%-plus in money-market funds with no risk.

Utility stocks have caught the attention of AI investors – for now. But don't let the hype suck you in.

History says the biggest gains of this rally have already happened... And that means this is a sector you should avoid today.

Good investing,

Brett Eversole

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