What happened
Shares of fintech stocks Upstart Holdings (UPST -1.45%), SoFi Technologies (SOFI -0.90%), and Affirm Holdings (AFRM -0.44%) all plunged on Friday, down 6.4%, 5.9%, and 7.5%, respectively, as of 2:41 p.m. ET.
With the consumer price index in August coming in slightly higher than expected, investors are convinced the Federal Reserve will raise interest rates potentially even higher than thought just a week ago. Meanwhile, last night's ominous warning from FedEx (FDX -0.56%) is stirring recession fears.
The combination suggests markets are very fearful the Federal Reserve will "overdo it," and tighten interest rates into an already weakening economy. That wouldn't be a good scenario for any company involved in lending, and especially newer, unprofitable fintech stocks that have yet to prove themselves in a recessionary environment.
So what
Last night, FedEx CEO Raj Subramaniam warned that FedEx would badly miss its quarterly earnings guidance, and pointed to a deteriorating macroeconomic environment. Since FedEx is a global company, investors appear to be extrapolating a worse-than-feared recession of some kind in 2023.
Tuesday's hotter-than-expected inflation report didn't help matters, as investors now believe the Fed might be even more hawkish in order to get inflation down, even though some sectors already appear to be in a recession.
Of course, the word "recession" usually means "sell financial stocks" to investors, and that's especially true if you're a financial stock that is currently unprofitable, as these three are.
Earlier this week, better-than-expected employment data and higher-than-expected retail sales seemed to indicate the U.S. economy was relatively strong. In response, these stocks had rallied before today. That's because higher interest rates actually benefit lenders, who can make more net interest income, as long as the economy doesn't fall into recession. SoFi even received an upgrade from an analyst, who posited that the Biden Administration's new plan for student loan forgiveness provided new clarity for SoFi.
Of the three, SoFi might be the safest play, as it tends to target well-off graduate students with attractive student loan refinancing, then cross-sells these promising borrowers other products as they enter the workforce and make more money.
In contrast, Upstart is an artificial intelligence (AI)-based lending platform for personal and auto loans, which targets "overlooked" borrowers who may have a low FICO scores but are actually more creditworthy, according to Upstart's AI models. Meanwhile, Affirm is a buy now, pay later platform for major retailers.
Both of those business models loan money to borrowers that may not be as well off, so there is a lot of fear that Upstart and Affirm may see increasing charge-offs if the macroeconomic picture darkens. That's why they are down 83% and 76%, respectively, and why they are down so much on a day when recession fears come to the fore.
In addition, the Consumer Financial Protection Bureau recently announced it would be looking into regulating the buy now, pay later space. That could be yet another headache for Affirm shareholders to deal with, although some analysts think it may strengthen its competitive position as one of the largest players in the space with the most advanced technology.
Now what
Since the fintech sector has been absolutely decimated in the current sell-off, it could also be the sector that stands gain the most, if -- and it's a big if -- we avoid a recession, or go through a mild recession where these companies make it through unscathed.
For those looking for big upside, all three of these stocks are prime candidates for a turnaround. However, investors in these stocks should also know that if there is a bad recession, their very existence could come into question.
I happen to think that's a long shot, but the fact that these companies were still unprofitable even in the good economy of 2021 does give investors reason for concern.
I would recommend researching these companies closely after these incredible sell-offs in order to gain confidence. If investors do gain confidence in management and believe these companies' liquidity would hold up even in a worst-case scenario, then the stocks could be huge bargains today, when looking past near-term economic troubles.
