Utilities: The AI Boom's Expectation Gap in 2026

The utilities sector has staged a powerful rally, but the market has already paid up for the AI-driven growth story. Through January 2026, the sector's year-to-date gains of 20.25% are a direct result of explosive optimism around data center demand. This isn't a slow burn; it's a sector that has surged from being the weakest in the S&P 500 in 2023 to delivering third-highest earnings growth among all eleven sectors in Q3 2025. The expectation gap is clear: the market is betting heavily on a future where AI power consumption transforms utilities from defensive staples into high-growth engines.

Yet the growth trajectory is decelerating sharply. The easy money from the initial AI demand wave appears to be fading. While Q3 2025 saw earnings growth of 23.1% year-over-year, the consensus view for the full year 2026 is a much slower pace of 9.1% growth. This is a classic "beat and raise" setup where the market has already priced in the beat, leaving the raise to be the next hurdle. The rally is now a game of expectations versus reality, with the easy growth phase ending.

Valuation confirms the market's forward-looking bet. The sector's forward P/E ratio of 21.93 sits well above its 5-year average of 20.13. In other words, investors are paying a premium for future growth that is projected to slow. This multiple expansion from a historical discount reflects the AI optimism, but it also means the sector is now trading at a level that assumes the growth story will continue to accelerate. Any stumble in the AI demand narrative could quickly reset those lofty expectations.

The Expectation Gap: Policy Shifts and Reality Checks

The bullish AI demand thesis is now facing a series of reality checks that could widen the gap between priced-in growth and actual outcomes. The sector's defensive reputation, once a reliable anchor, is being tested as it has outperformed the broader market, a role typically reserved for growth sectors. This shift calls into question the very definition of what utilities are now priced for.

A major policy reset is forcing a strategic pivot. The One Big Beautiful Bill Act has axed most subsidies for clean energy and electric vehicles, creating a hostile federal environment for renewables. This sudden change in the regulatory landscape is a direct headwind to the growth narrative, compelling utilities and developers to rethink their investment plans and resource mix.

At the same time, the market is grappling with the risk of overbuilding. The data center frenzy has led some to fear a repeat of the early 2000s tech bubble, where massive infrastructure was built for anticipated demand that never materialized. Signs of a slowdown are emerging. Some utilities that introduced more stringent interconnection rules for data centers have already seen their large load queues shrink by 50% or more. The U.S. Energy Information Administration has revised down its 2026 generation growth forecast based on actual demand coming online so far. This is a classic "guidance reset" in the making, where initial aggressive predictions are being tempered by on-the-ground reality.

The bottom line is that the sector's rally has been driven by a powerful, forward-looking bet. Now, that bet is being tested by a combination of policy shifts, potential overbuilding, and a decelerating growth trajectory. The expectation gap is no longer just about AI demand-it's about whether the sector can navigate these new headwinds while still delivering the growth the market has already paid up for.

Catalysts and Scenarios: What Could Close or Widen the Gap

The market's verdict on the utilities sector hinges on a few key metrics and events in 2026. The primary catalyst is the actual build-out of data center capacity and its power consumption. The sector's rally has been priced for a surge in demand, but that optimism will be tested by hard data on how much load is coming online. The expectation gap will close if this build-out meets or exceeds current forecasts; it will widen if it slows, as early signs suggest.

A major watchpoint is guidance from the sector's bellwethers. Companies like NextEra Energy and NRG Energy are positioned to capture this expansion, and their forward-looking statements on data center contracts and infrastructure investment will be critical. Any upward revision to their growth outlook could validate the bullish thesis. Conversely, a more cautious tone or a guidance reset would signal that the easy growth phase is ending faster than expected.

The policy shift is a parallel risk that could widen the gap. The One Big Beautiful Bill Act has created a hostile federal environment for renewables, which could introduce unforeseen costs or delays for utilities planning new generation. While the sector may pivot to other resources, the regulatory uncertainty adds friction to the investment plans that are central to the AI growth story.

The bottom line is that 2026 is a year of reckoning. The market has already paid up for the AI boom. Now, the catalysts are about whether that boom materializes as promised. The coming months will reveal if the data center load queues are shrinking due to smarter vetting or a genuine slowdown. The sector's ability to navigate policy headwinds while delivering on its contracted growth will determine if the current price is justified or if a painful reset is due.