Utility stocks have been shunned, leaving the sector looking highly attractive.

The State Street Utilities Select Sector SPDR ETF, home to many regulated utility providers, is down about 9% from its record peak in late February. That decline has brought the fund near a record low relative to the S&P 500. While chip stocks and many other sectors have risen amid enthusiasm over artificial intelligence and data-center spending, utilities have fallen further behind the broader market. The fund hit its lowest level relative to the S&P 500 on Aug. 6.

The main problem has been the 10-year Treasury yield, which is up almost 0.7 percentage points from a late-February low. The Middle East conflict added to inflation pressures, pushing yields higher and making utilities' dividends less attractive relative to risk-free Treasuries. Utilities are particularly sensitive to changes in bond yields compared with other sectors.

Also not helping has been political backlash against data centers, which are major sources of new electricity demand.

Governors and other elected officials have pushed for greater scrutiny of projects amid concerns that residents could end up bearing the costs of infrastructure built to serve them. Some officials want utilities to demonstrate firm commitments from data-center customers before moving forward with new power investments.

The resulting selloff means utility shares already reflect much of that risk. The 10-year Treasury yield has repeatedly failed to break above 4.7% this year, while political resistance is unlikely to eliminate the underlying growth in electricity demand.

Utilities are "inexpensive relative to broader equity markets, and carry significantly lower beta [lower risk]," write strategists at Manulife John Hancock Investments. "We continue to like the underlying fundamentals."

Those fundamentals haven't disappeared because of the political backlash. States aren't necessarily telling utilities to cancel projects, and scrutiny over who pays for new infrastructure doesn't eliminate the underlying demand for electricity from AI and data centers.

Instead, some data-center spending could happen more gradually, slowing near-term growth but potentially extending investment over a longer period. That creates uncertainty around utilities' future cash flows, but it also means they could delay some of the borrowing or stock issuance needed to finance those projects. That means utility providers may still be worth close to what they were before the political backlash flared up.

"The political and regulatory environment...does not necessarily weaken the underlying AI power thesis," writes Siebert Williams Shank analyst Christopher Ellinghaus. He notes that utilities can focus on ensuring projects are backed by committed electricity demand rather than building power infrastructure based on expectations that demand will eventually materialize.

One example is Southern Company, which serves Georgia, Alabama, and Mississippi. In Georgia, the utility submitted a proposal for investment in "large load" projects for state review that require customer commitments before investments move forward. Separately, Southern has signed a 25-year power agreement with OpenAI.

At recent investor meetings, Southern management said its growth targets had been tested against a range of regulatory outcomes and emphasized that its contracts are structured so customers bear the costs of incremental investment, according to Mizuho analyst Anthony Crowdell.

Many utilities are positioned for growing earnings, partly because of data-center projects. When regulated utilities increase capital spending, state regulators generally allow them to earn a specified rate of return on those investments. Analysts expect aggregate earnings per share for companies in the utilities fund to grow about 9% annually over the next two years, according to FactSet.

That growth could help push the fund higher. It trades at just 16.8 times expected earnings over the next 12 months, roughly a 15% discount to the S&P 500's multiple of just under 20 times. Over the past five years, the midpoint has been a discount of just 3%. Utility valuations could get a boost if yields fall or political opposition to data-center spending proves less disruptive than feared.

That potential comes from a sector that is typically far less volatile than the broader market, giving utilities an advantage over investments such as chip stocks, where swings can be extreme.

For investors looking for upside without taking on the volatility of the hottest AI trades, utilities look hard to ignore.