Today’s post will first cover the latest “news of the moment,” the credit downgrade. Following that will be the beginning of Cornerstone’s analysis of an important evolving investment thesis – the remaking of U.S. energy.
First, let’s touch on the Moody’s downgrade of the U.S. sovereign debt rating from Aaa to Aa1. Keep in mind, Moody’s was the last of three major ratings agencies to downgrade American debt.
While many might call for stocks to crater, we believe that outside some near-term market weakness, the downgrade itself is largely immaterial. Moody’s was just late to the party for whatever reason:
The reason being is that there’s no surprise here and no new incremental information as a result.
As our long-time readers know, we’ve covered this risk before, going into detail on how the federal budget deficit is nearly $2 trillion a year, which is more than 6% of gross domestic product.
We've also analyzed the budget deficit increasing as borrowing costs rose. We've already seen this reflected in how the fiscal deficit in the year that began on Oct. 1, 2024, is already running at $1.05 trillion, 13% above the previous year.
But again, none of this is new information. It doesn't change how markets look at U.S. debt.
The Moody’s commentary has been obvious to any analyst that’s been paying attention. Back in 2000 was the last time there was a budget surplus. As you can see, the trend for the past 25 years across all administrations has been to increase the debt-to-GDP ratio from 55% to 122%:
(Year, Accumulated Federal Debt (billions), Debt-to-GDP ratio, Major Event(s) that year)
Besides some bad headlines, we don't see how this changes anything for the US debt picture fundamentally:
- The corporate costs of debt will be largely unchanged.
- Corporate earnings per share visibility will remain unchanged.
- Consumer demand will be largely unchanged.
- Bears will still wish for stocks to fall.
Still, in the near term, this gave the market a reason to take some profits during a budding rally. In the Big Money Index below from our friends at MoneyFlows, you can see an almost immediate topping out:
For seasoned investors, short-term rate shocks are nothing new. Often, they provide a reason to trim some profits. Our expectation is this event will be short and follow patterns from previous debt downgrades:
There could be some bumpiness. But looking farther out, returns are strong in 100% of observed instances.
Transformational Changes Taking Place
As earnings season ends, the typical lull in financial data is here. So, we want to discuss a secular investment theme that’s quickly gaining speed.
As asset managers, it’s important to look forward in anticipation of meaningful investment themes on the horizon, like the transformational changes taking place in electrical power/grid infrastructure.
Upgrades meant to increase capacity as well as modernize our electrical systems are incredibly important, especially for the future needs of AI. One example is natural gas. The U.S. S&P Global Market Intelligence report from May 2024 said, “U.S. utilities and investors plan to add 133 new natural gas fired power plants to the nation's grid over just the next couple of years.”
This would help solve the immediate demand for more power. The expansion of natural gas, which is cheap, clean, and abundant, is quickly becoming the foundation of many electrical system upgrades, keeping us from importing energy.
And it’s just the start. AI workloads are expected to push data center electricity consumption from 4.4% of total U.S. electricity needs to over 12% by 2028.
For perspective, Goldman Sachs Research projects occupancy rates of our data center infrastructure to increase from around 85% to more than 95% by late 2026:
This is important because Goldman Sachs estimates the current power usage by the global data center market to be around 55 gigawatts. This is comprised of cloud computing workloads at 54%, typical business functions like e-mail storage at 32%, and AI at 14%.
Goldman's analysts project power demand will reach 84 gigawatts by 2027, with AI growing to 27% of the overall usage. As AI processing workloads increase, the density of power use in data centers is expected to grow from 162 kilowatts per square foot to 176 kilowatts per square foot by 2027.
The inability to meet this demand has been the biggest constraint over the past 18 months in data center infrastructure supply:
Thus, it’s clear the electric grid requires significant investment – Goldman Sachs estimated about $720 billion of grid spending will be needed through 2030. Using the latest data available, in 2023 alone, capital investment in electric transmission systems reached $27.7 billion while distribution infrastructure spending hit $6.5 billion.
There will be a number of winners because of all this investment. But right now, the biggest is natural gas because it can be built and activated significantly faster than other energy sources.
To put this in perspective, in 2022 the construction cost for natural gas fired power plants was $820 per kilowatt. Solar power was $1,588 per kilowatt. Wind was $1,451.
This reality has translated to shorter construction timelines and is reflected in the share of total electricity generated by source:
The current U.S. electric grid is highly fragmented and uncoordinated among the dominant electric utilities. There are three separate interconnections:
- Eastern
- Western
- ERCOT (the Electric Reliability Council of Texas)
Each one functions in almost total isolation. This is by design to ensure stability.
But today, this fragmentation combined with the model where utilities are granted exclusive control over electricity generation and distribution, is a problem. Therefore, the other transformation taking place is a transition to a national smart grid model where all major utilities talk to each other and do business with each other.
In this model, if there was a brownout in New York, power would be made available by other networking partners through a highly automated transmission and distribution system using all forms of energy:
In our opinion, this is an amazing investment opportunity as America's smart grid doubles or triples its capacity over the next decade. Well-run companies across a handful of energy subsectors should outperform the market averages. A few examples of which are as follows:
It’s the type of secular investment theme that’s essential to the very existence of our domestic economy.
* Links to third-party websites are being provided for informational purposes only. CoreCap is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. CoreCap is not responsible for the content of any third-party website or the collection or use of information regarding any websites users and/or members.
*Past performance does not guarantee future results.
*Investing involves risk and you may incur a profit or loss regardless of strategy selected.
* American Power, NextEra Energy, Energy Transfer, and Enterprise Products Partners are owned in Cornerstone client accounts.
# Enterprise Products Partners is owned by Daniel Milan personally.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.