The sector in the cross hairs of the bond sell-off looks poised for a bounce, says Mike Khouw

• XLU has erased all Q1 gains, with independent power producers like Constellation, NRG, and Vistra seeing earnings multiples compress 2 to 8 turns from recent peaks due to rising rates
• AI-driven power demand remains a multi-year tailwind as tech giants secure long-term power purchase agreements (PPAs) for data centers, creating upside potential for earnings estimates
• Khouw proposes buying the XLU November 40/43 call vertical spread for $0.85 net debit, targeting a move back to the 50-day moving average within seven to eight weeks

Summary

Key Development: The utilities sector, represented by the Utilities Select Sector SPDR ETF (XLU), has sharply declined due to the fastest rise in Treasury yields since 1994, erasing all Q1 gains. Despite this selloff, analyst Mike Khouw sees a bullish opportunity for a rebound.

Market Dynamics: The sector faces competing forces: AI-driven power demand creating unprecedented earnings potential versus rising interest rates pressuring dividend-focused, capital-intensive utility stocks. Independent power producers like Constellation, NRG, and Vistra have seen earnings multiples compress 2-8 turns from recent peaks. Rising bond yields make utilities' dividends less attractive compared to fixed-income alternatives.

Valuation & Fundamentals: XLU currently trades at its 10-year average P/E multiple of 17.8x, offering a more attractive entry point than earlier this year. The fundamental thesis remains intact: tech giants continue emphasizing massive, multi-year energy needs for AI infrastructure and data centers through long-term power purchase agreements (PPAs).

Catalysts: Potential relief from easing Iran tensions could lower oil prices and yields, while weaker-than-expected jobs data is already pressuring rates lower. Wall Street estimates may underappreciate upside from upcoming data-center power deals and grid reliability needs.

Trading Recommendation: Khouw suggests a bull call spread on XLU—buying November 40 calls at $1.15 and selling November 43 calls at $0.30, for a net debit of $0.85. The strategy targets a recovery toward recent highs over 7-8 weeks, with resistance near the 50-day moving average. Low implied volatility makes option spreads cost-efficient for this defined-risk bullish position.

Bottom Line: Rate-driven selloff creates buying opportunity in sector with strong secular AI power demand tailwind.