Industrials and utilities companies are capturing the first dollars of the artificial intelligence spending cycle. That may not be where most investors are currently focused.

Key Takeaways

• Industrials and utilities companies are collecting the immediate earnings benefits of AI’s capital spending cycle.
• Tech valuations have stretched, and rising rates could weigh on the sector’s future cash flows.
• U.S. companies hold roughly three-quarters of global market cap in information technology and communication services.

That’s the central argument from Matt Bartolini, global head of research strategists at State Street Investment Management. In an interview with S&P Dow Jones Indices, Bartolini said sectors tied to physical infrastructure are drawing the immediate benefits of AI’s capital expenditure wave, while information technology faces rising valuation pressure.

Tech companies are driving AI capital spending, Bartolini said, but their actual earnings rewards are further out on the horizon. Right now, spending is flowing to companies constructing data centers, power grids, and the physical systems AI requires.

“They’re getting that first dollar of spending, and that’s why we see some of the earnings growth right there in an immediate perspective,” he said.

Two sector-specific funds offer direct exposure to both groups. The State Street Industrial Select Sector SPDR ETF (XLI) holds $33.1 billion in assets with an 0.08% expense ratio, per ETF Database. Meanwhile, the State Street Utilities Select Sector SPDR ETF (XLU) targets the utilities companies building out the power infrastructure AI systems demand.

Bartolini also flagged the energy complex as an opportunity. Inflation has stayed above where the Federal Reserve would prefer. That dynamic, combined with ongoing shifts in global energy markets, has made natural resource equities in the energy and materials sectors worth considering, he said.

See more: Financials Rose, Tech Fell Before Kevin Warsh Fed Debut

Why Industrials Edge Out Tech Near-Term

Information technology carries the bigger near-term risk. Investors have piled into the sector for years, and Bartolini acknowledged it has been a winning trade.

But the capital expenditure flowing into AI is now facing scrutiny over whether it can actually deliver the expected growth, he said. Valuations have stretched.

Rising rates add another layer of pressure. Tech stocks function as long-duration assets, meaning their value relies heavily on cash flows expected years from now. Any climb in interest rates could weigh on those future values, Bartolini said.

U.S. companies account for roughly three-quarters of global market capitalization in both information technology and communication services, according to Hamish Preston, head of U.S. equities at S&P Dow Jones Indices. That concentration gives U.S. sector decisions outsized importance for investors worldwide.

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