Why infrastructure stocks are outperforming Big Tech

The diminishing performance of mega-cap tech companies relative to the broader market is becoming more pronounced, as investors grow uneasy about mega spending on what’s known as hyperscaling.

That’s the term of art for these companies’ astronomical capital expenditures to build data centers for artificial intelligence functions. Many investors used to have no problem with all this spending.

But more are now questioning the potential for commensurate returns on hundreds of billions of dollars in capital expenditure to develop this digital infrastructure, much of it for advanced semiconductors from industry leader Nvidia.

So, as Nvidia’s leather-jacketed CEO, Jensen Huang, acts like a rock star by signing autographs for adoring fans, investment is flowing from big tech to other sectors.

This cash siphon had become dramatically clear by mid-February, according to Schwab, when more than 62% of the stocks in the S&P 500 were beating the index itself—nearly three times as many as over the preceding 12 months, when performance was concentrated in big tech companies, especially the Magnificent Seven.

Among the sectors with currently accelerating returns are industrials, as the economy appears to be setting the stage for what market economist Ed Yardeni forecasts as the “Roaring 2020s” — a 21^st-century reincarnation of the decade a hundred years ago when American industry was on steroids.

For many investors, shifting sector performance may suggest changes in portfolio allocations. When seeking to identify forces likely to drive equities over the next few years, investors might want to ask the following questions:

Does a company’s enterprise directly or indirectly involve products, services or materials used in the generation, conducting, regulation, management or storage of electricity? Does it involve things that hum, buzz or glow?

Hooked on juice

America is addicted to easily accessible and readily available electrical power. We take it for granted, oblivious to the inconvenience common in less developed nations, where planned, rotating outages are a way of life.

The amount of power Americans need is increasing apace as they run and charge an ever-expanding array of devices, from robotic vacuum cleaners to lawn mowers to teeth flossers to toilets (yes, toilets) to devices competing for household Wi-Fi bandwidth to electric (EV), hybrid and plug-in hybrid vehicles — despite electrical grids that sometimes strain to provide that power.

Vastly increasing this demand are data centers, so much so that tech companies are making deals with public utilities for proprietary generation to assure sufficient supply, and to address public opposition to data centers over potential impacts on rates.

Industrial products that hum, glow or buzz, and items and services that enable this, fall into the industrials category known as infrastructure.

Historically, this category comprised little more than roads, bridges, tunnels, railways and ports, and the services, items and raw materials necessary to build and maintain them, along with the power generated by plants to run them. Traditional infrastructure companies include those held by the exchange-traded fund (ETF) Global X US Infrastructure Development (PAVE).

The definition of infrastructure was broadened by the Infrastructure and Jobs Act of 2021, which included funding for the development of access to broadband internet. Further expanding this definition, the following year, Congress passed President Biden’s CHIPS and Sciences Act, intended to foster the domestic manufacture of advanced semiconductors.

Expanding universe

This broader infrastructure investment universe includes the colossal data centers being built to enable digital services we didn’t know we couldn’t live without. This category comprises some esoteric engineering fields, such as those for chip technology, including metallurgical processes and the application of ultra-high-purity gases.

The recent cooling of investors to AI hyperscaling is driving more investment into elements of the new infrastructure, some of which are big vendors for data centers but derive substantial revenue from other industries.

Industries in the new infrastructure include:

• Companies that manufacture items or provide services to manage or facilitate electricity in a wide range of industrial settings. Major players include EMCOR Group (EME), Quanta Services (PWR), Eaton (ETN), Powell Industries (POWL) and Corning (GLW).

As of late February, Corning was up an astonishing 130% over six months and Eaton, about 25% in 12. Research firm CFRA rates Corning a buy and Eaton a strong buy.

While these companies benefit from hyperscaling, the good news for investors seeking diversification is that their performance hasn’t been particularly correlated with that of big tech. This is also true of a handy power-grid, gear and service ETF, First Trust Nasdaq Clean Edge (GRID). Among the stocks this fund tracks are Quanta and Hubbell (HUBB), up nearly 40% in the last 12 months.

• Metals. Steel has always belonged in the infrastructure category. Yet now, specialty steel is used in servers and other hardware, whereas silver (the most conductive metal) also plays a major role, as copper does for wiring in general. Copper has posted major gains in recent months, with miner Freeport-McMoRan (FCX) up more than 60% over the last six (rated buy by CFRA). Rising copper prices usually bode well for industrial and economic growth in general. (This bellwether role has earned it the monikers Dr. Copper and King Copper.)

Copper, steel, aluminum and silver are tracked by the SPDR S&P Metals & Mining ETF (XME), which is up 104% in the past 12 months.

Though EV demand has fallen short of projections, metals used in these batteries and those for hybrid and plug-in hybrid vehicles — primarily lithium, nickel, cobalt, manganese and graphite — have continued to do well.

EV adoption is slower than expected, but these metals nonetheless have long-term potential, as EV proliferation is pretty much inevitable. Two ETFs in this space: Global Lithium Battery Tech ETF (LIT) and ProShares S&P Global Battery Metals (ION).

• Power companies. Once viewed as a highly defensive investment because they provide low yet steady returns, power companies have increased their appeal in the last couple of years with vastly improved returns, including those of stellar performers General Electric spinoff GE Vernova (GEV) and Vistra Corp. (VST).

A major factor enhancing returns is the nuclear power renaissance, which has developed now that public opposition to nuclear generation has greatly diminished, enabling the proliferation of new reactor plants in Europe and the U.S. Nuclear power funds include VanEck Uranium + Nuclear Energy ETF (NLR) and Range Nuclear Renaissance ETF (NUKZ).

Power companies will, of course, reap a bonanza from artificial intelligence (AI) hyperscaling, as the specialized servers involved use astonishing amounts of juice. One astonishing projection estimates that just the data centers currently under construction could ultimately require as much power as that used by all of Italy.

Fertile environment

These industries reflect the growth of industrials in general, which broke out of the doldrums and began gaining last spring in the market’s comeback from the April tariff-announcement slide. State Street Industrial Sector SPDR ETF (XLI) was up 13% year to date as of Feb. 25. And the related sector of materials — items manufacturers use to make stuff — has risen significantly in the last few months after languishing for a couple of years.

The current economy shows strong signs of being the beginning of Ed Yardeni’s Roaring 2020s.

Even amid the uncertainty of shifting tariff policy, recent and projected corporate earnings remain strong. And as of January, durable goods data reflected a boom in nondefense capital goods (excluding aircraft), which Apollo recently noted as the onset of an “industrial renaissance.”

In the shorter term, hefty income tax refunds (from excess withholding relative to actual tax under new legislation) will give the economy a shot in the arm.

Increasing industrial growth would mean more humming, buzzing and glowing from the new infrastructure, likely benefiting investors who choose stocks and funds judiciously.

Dave S. Gilreath, CFP, is a partner adviser at Allworth Financial LP, an investment advisory firm registered with the U.S. Securities and Exchange Commission. Investments mentioned in this article may be held by Allworth Financial, affiliates or related persons.