* Utilities gain as investors seek defensive sectors amid

Middle East conflict and market volatility

* Rising AI-driven electricity demand boosts sector

* Ceasefire prompts shift back to cyclical stocks, with

fund managers eyeing growth sectors

By Chibuike Oguh

NEW YORK, April 10 (Reuters) - U.S. utility stocks

marked their strongest start to the year since 2019, benefiting

from an investor retreat from riskier assets during the Iran war

and strong electricity demand from firms building out artificial

intelligence infrastructure.

The S&P 500 Utilities Index gained 7.5% in the

first quarter, notching its strongest opening stretch since the

first quarter of 2019, according to LSEG data.

The S&P 500 index fell 4.6% in the same period - its

worst quarter since 2022 - dragged down by inflation worries as

energy prices spiked. The index has since recovered some ground,

approaching a one-month high this week after the U.S. and Iran

agreed to a two-week ceasefire.

The first-quarter gains in utilities stem from their

traditional role as a defensive sector, offering investors

opportunities for steady dividend payouts and lower volatility

during market swings.

Other so-called "bond proxies" including stocks in the S&P

500 Real Estate and the S&P 500 Consumer Staples

also gained during the first quarter.

"When volatility really ramps up and there are questions

about where the market is going in the short term, it's natural

for investors to rotate into defensive type equities and

utilities tend to be a prime recipient of along with

healthcare," said Matt Stucky, chief equities portfolio manager

at Northwestern Mutual.

AI DEMAND

Utility stocks benefited from increasing electricity demand

from large technology companies that are building massive data

centers in their drive to dominate artificial intelligence.

Electricity demand from data centers could more than quadruple

by the ⁠end of the decade to consume as much as 17% of U.S.

power supplies, according to research by the Electric Power

Research Institute, EPRI.

"I read a few recent quarterly calls from some of the

utility companies and the big drivers are the data centers and

the increased electricity demand, which is crowding out other

interests," said Gerry Sparrow, president at Sparrow Capital

Management.

"The data center demand is coming from technology companies

-- in particular Alphabet, Meta Platforms ( META ) and

Oracle, with their capital budgets that include data

center buildout for AI. So that's some of the stuff that's

moving the market around, especially around individual utility

companies."

RISK-ON TRADE

With the U.S.-Iran ceasefire now offering markets a window

of relative calm, fund managers will likely begin to rotate out

of defensive positioning and back into more cyclical and growth

oriented names.

This might result in the utilities sector paring some of its

recent gains. However, utility companies with direct exposure to

the AI buildout - particularly those serving commercial

customers in data center corridors in Virginia, Texas, Florida

and the Midwest - are expected to retain investor interest,

Sparrow said.

Those companies include American Electric, Dominion

Energy ( D ), Nextera Energy ( NEE ), Xcel Energy ( XEL ) and

Duke Energy ( DUK ).

"A lot of the performance is likely going to be tied to how

much they're serving industrial customers versus residential

customers closer to the larger cities," Sparrow said.