What happened

Shares of fintech up-and-comers SoFi Technologies (SOFI 0.26%), Upstart (UPST 0.79%), and Affirm (AFRM -2.08%) plunged on Friday, ending the session down by 6%, 8.5%, and 10%, respectively.

All three companies had previously been up quite strongly for the week following last week's better-than-feared retail sales report. However, on Friday, S&P Global released the results of its Purchasing Managers' Index (PMI) survey for July, which showed a large deterioration in the state of U.S. manufacturing. That result re-intensified the market's recession fears, sending the major indexes lower and taking these economically sensitive stocks down even more sharply.

So what

S&P Global's PMI survey for July came in with a surprisingly bad 47.5 reading, down from 52.3 in June. Any reading below 50 indicates a contraction, which means that at least parts of the U.S. services and manufacturing economy could be headed for a recession. Additionally, S&P's PMI reading for the Eurozone slid from 52.0 last month to 49.4 in July.

The PMI results stand in contrast to last week's June retail sales report, which showed surprising strength on the part of the U.S. consumer.

With conflicting reports showing both too-hot and too-cold readings, it's no wonder that these fintech stocks are getting whipsawed around, with near double-digit percentage moves on a daily basis.

SoFi is primarily a lender targeting graduate students, but it has evolved into a diversified digital financial services platform spanning lending, brokerage, credit and debit cards, and checking and savings accounts. Upstart is also a lender of sorts, using artificial intelligence to underwrite loans to borrowers who might not qualify for loans based on their traditional FICO scores, then selling those loans to third-party financial institutions. Meanwhile, Affirm operates a "buy now, pay later" platform for retailers.

Each of these fintech companies is highly sensitive to the financial health of borrowers, which in turn is dependent on the health of the economy. If the U.S. is headed for a recession, lenders' charge-offs could increase across the board. Of note, Upstart has seen a higher-than-expected uptick in charge-offs on its 2021 vintages this year, prompting concerns over its real underwriting advantages.

Now what

Not only are these three companies highly sensitive to the economic outlook, they are also relatively young high-growth operations, and still at the stage of their existences where they are losing money on a GAAP basis.

That combination of high growth and lack of profitability makes them more sensitive to long-term interest rates. With inflation at a 40-year high, it's unclear how high and how fast the Federal Reserve will raise its benchmark interest rates. While some believe that a recession would bring annual inflation rates back down to the Fed's 2% long-term target, other experts have been saying that part of the current inflation surge may prove "stickier" than previously expected. Thus, it's possible the U.S. could be headed toward a higher interest rate environment than prevailed in the period immediately prior to the pandemic.

All in all, early-stage fintechs with new business models are a risky bet these days. No doubt, since these stocks are down so much from their all-time highs, they could offer significant upside to new investors. But those gains can only come if the economic situation calms down, and that might not happen for a while. Additionally, now that these companies have seen skepticism creep into their stories, they will need to show that their business models are sustainable in an economic down-cycle, and how they fare in comparison to their legacy financial industry competitors.

That will be a tall order. While I would monitor these exciting companies, I'd recommend keeping them at arm's length from your portfolios during this highly uncertain period.