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Client Update - 17th May 2024

Appleton Fox

Last Friday brought encouraging news for the UK as data revealed that we have exited the technical recession we slipped into in the last quarter of 2023. First-quarter growth for 2024 reached 0.6%, surpassing the Bank of England's forecast of 0.4% and exceeding expectations from economists polled by Reuters. Additionally, the FTSE 100 has maintained its upward trend, gaining over 9% since the start of the year. It seems that just when investors were beginning to lose hope in the index, growing expectations that the Bank of England will soon cut rates has revitalised sentiment.


Similarly, to the FTSE 100 index, the Utilities sector is often viewed as one of the more unexciting areas of the equities market. Unsurprisingly, given that utility companies tend to perform poorly during periods of persistently high interest rates, the S&P 500 Index’s Utilities sector fell 10% in 2023, marking its worst year since 2008 and the weakest group in the equities benchmark. However, these utility stocks have staged a remarkable turnaround over the past few months, gaining 10% since the start of April. While the prospect of rate cuts this year, a slowing economy and solid industry fundamentals may have initiated the sector’s rally, the developing narrative around the role of Utilities in artificial intelligence (AI) is now driving returns.


AI systems, including large language models like OpenAI's ChatGPT and Google's Bard, rely on vast data centres filled with specialised computers. These data centres require substantial power and water-intensive cooling systems. Consequently, investors are increasingly turning their attention to the Utilities sector, recognising that as the demand for AI technology grows, so will the need for the energy to power and cool these servers.


A recent study by Alex De Vries, PhD, found that if the current growth rate of AI continues and Nvidia produces 95% of the AI processing equipment, AI could consume approximately 85-134 terawatt-hours (TWh) of electricity each year. This is roughly equivalent to the annual electricity consumption of the Netherlands and about half a percent of global electricity consumption.


This study supports the views of Sam Altman, CEO of OpenAI and co-developer of ChatGPT. Speaking at the World Economic Forum in January, Altman emphasised the crucial need for an energy breakthrough to support the future development of AI. He highlighted that AI technology will consume much more power than initially anticipated, necessitating the exploration of climate-friendly energy sources such as nuclear fusion, cheaper solar power, and storage.


These views are echoed by the CEO of Exelon Corp, a leading competitive energy provider in the US, who recently stated that AI is poised to drive a 900% increase in power demand from data centres in the Chicago area alone. This surge in demand could require as much electricity as four nuclear power plants can produce. Similarly, Southern Company in the US predicts its electricity sales will grow by 6% annually, with about 80% of this growth coming from data centres. Analysis published in April by Wells Fargo suggests that after a decade of flat power growth in the US, electricity demand is forecast to increase by as much as 20% by 2030.


These projections are promising for the utilities sector. While the full extent of the AI revolution's impact remains uncertain, it is likely that the utilities sector stands to benefit significantly. This view is shared by our investment team, who incorporated utilities into their models earlier this year as a defensive play while awaiting global interest rate cuts—an allocation that has performed well. The core High Dividend Low volatility ETF has a high weighting to US Utilities and the Tailored MPS strategies have higher direct exposure to a US Utilities Sector ETF. Since bringing these holdings into the models the team has further increased their allocation, based on the expectation that AI’s power demand will drive higher returns. It is this sort of timely active investment management that can really drive positive portfolio returns. With central banks, likely led by the Bank of England, expected to start cutting rates in the coming months, we believe the utilities sector is poised for further support and growth.


Do have a good weekend.

 
 
 

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