AI Investment Spillover! Wells Fargo: Capital Goods and Industrial Stocks to Benefit, Watch Midterm Election Political Risks

Wells Fargo stated that capital expenditures by tech giants on artificial intelligence (AI) are beginning to 'spill over' into the broader economy, potentially further boosting industrial stocks.

Wells Fargo strategist Ohsung Kwon, in a report released Tuesday (4th), indicated that as data center construction continues to expand, industrial stocks will be the primary beneficiaries. In particular, capital goods companies that produce machinery, equipment, and tools needed for factory construction have become one of the 'most closely linked' sectors to AI, with their stock performance increasingly moving in tandem with the semiconductor industry.

"Over the past few months, capital goods stocks have become the industry with the highest correlation to semiconductors," Kwon said, noting that multiple signs already indicate AI investment is gradually transmitting to industrial companies.

Wells Fargo estimates that U.S. manufacturing activity expanded at the fastest pace in over four years in July, with non-AI-related capital expenditures growing 10% year-on-year, while commercial and industrial loans also accelerated.

Over recent months, investors have continued to increase exposure to so-called 'Old Economy' sectors, leading to a rotation in the market leadership of the S&P 500 index this year.

Industrial stocks have risen 20% year-to-date, trailing only energy and information technology sectors in performance.

Caterpillar Benefits from Data Center Demand

Caterpillar (CAT-US), a major construction equipment manufacturer, is one of the representative beneficiaries. The company's stock surged 5.6% on Tuesday, driven by strong earnings growth in Q2 due to rising demand from data center construction.

Known as the 'canary in the coal mine' for economic health, Caterpillar released strong earnings before market open on Tuesday, closing the day with a 5.6% gain.

The earnings report showed that demand for power generation and construction equipment driven by AI data center construction pushed both revenue and profits above Wall Street expectations. Quarterly revenue surpassed $20 billion for the first time, and the company simultaneously raised its full-year revenue growth outlook while lowering its tariff cost estimates.

Caterpillar's Energy & Transportation segment has recently surpassed its most well-known construction machinery business (such as excavators) to become the company's largest and fastest-growing division. As a result, investors have begun to categorize Caterpillar alongside power equipment firms like Vertiv and GE Vernova as an AI-related stock.

However, this has also drawn attention from short sellers. Michael Burry, the investor famous for shorting the subprime crisis and the inspiration for the movie 'The Big Short,' revealed on June 30 that he had initiated a short position in Caterpillar for the first time.

Burry noted that after Caterpillar's stock surged over 150% in the past year, it had become one of the most overvalued beneficiaries in the AI investment boom. "Caterpillar has caught my attention. I've never shorted Caterpillar before; it was actually one of my favorite long positions in the past."

On the day Burry's short position was disclosed, Caterpillar's stock hit an all-time high of over $1,070 per share on July 2. On Tuesday, the stock closed at $876.54 per share.

Political Backlash as the Biggest Risk

Kwon estimates that approximately 40 large data centers are currently under construction across the U.S., with over 100 more in the planning stages, primarily concentrated in Texas, Georgia, Virginia, and Pennsylvania.

"We're now seeing that data centers already in operation are bringing economic benefits to their local regions. If this is truly the new trend of the future, then the spillover effect of AI investment into the broader economy is still in a very early stage," Kwon said.

However, Kwon also warned that the rapid expansion of data centers has raised public concerns about electricity prices, water consumption, and environmental impacts on communities, potentially leading to increasing political resistance in the future.

"I believe the biggest risk to data center construction is political backlash, especially as the November U.S. midterm elections approach, when this issue may receive greater attention," he said.