What happened
Shares of new fintech companies Upstart (UPST -7.19%), SoFi Technologies (SOFI -0.71%), and Affirm (AFRM -9.34%) rallied today, up 7.3%, 5.1%, and 13.7%, respectively, as of 12:20 p.m. ET.
These fintech stocks have been among the most beaten-down amid this year's bear market. First, higher interest rates took down the multiples for all stocks, especially growth stocks such as these three. As the Federal Reserve hiked interest rates more aggressively to fight inflation, investors feared a recession and therefore charge-off risks to these new lenders.
However, if inflation and interest rate trends reverse, these stocks can rally very hard, as we are seeing today. Recent days have seen widespread buying, as interest rates have come down and leading indicators of inflation seem to be cooling fast.
So what
The 10-year Treasury bond yield was down again today, falling below 3.6% after exceeding 4% just last week. This is important because long-term Treasury yields are often used as a baseline to discount equities. So, a lower 10-year Treasury yield means a lower discount rate applied to future earnings.
Growth stocks should benefit disproportionately in that trend reversal. Long-term Treasury yields also factor in future inflation to their prices, so to see long-term yields go down means investors don't see inflation staying as high as it currently is.
While higher interest rates are normally good for banks and financial companies, newer fintech stocks have the problem of funding to contend with. Upstart relies on third-party banks and credit unions and saw a buyer's revolt earlier this year as interest rates rose rapidly.
Affirm relies on warehouse facilities, securitizations, and other forward-flow commitments to fund its loans, and the costs of these funding mechanisms also rise with short-term interest rates. While SoFi has a banking license, it's repeatedly had to raise the rate it pays to depositors this year in order to attract customers.
Needless to say, even though these companies make money from loans and charging interest, a rapid rise in interest rates is actually not a great thing for them or their competitive positions versus traditional lenders that typically have lower funding costs.
Why are long-term Treasuries down so much? The past few days have seen some cooling signs of inflation, and those signs have come in the most problematic inflationary pockets of the economy: housing and labor.
Yesterday, a report from mortgage-data provider Black Knight said housing prices fell 0.98% in August, following a 1.05% decline in July.
Some may think falling home prices are bad for the economy and lenders, and in normal times, that may be true. However, we are in a period of very high inflation that the Fed is aiming to control. One of the Fed's preferred measures of inflation is "core" CPI, which strips out volatile food and energy prices, and shelter costs make up a huge 40% of core CPI.
Shelter costs are calculated with a big lag after house prices go up, and this is largely why the core CPI measures have disappointed to the upside in the last month. However, if the red-hot housing market finally stops rising and even goes down a bit, that should allow core CPI to come down significantly in the months ahead. And that would allow the Fed to slow or pause interest rate hikes that have hurt stocks so much, especially these smaller fintech names.
Meanwhile, the other problematic part of the inflation equation has been labor, as demand for workers has been outstripping supply after the pandemic. Once again, we got another "bad news is good news" data point on that today, as the Labor Department's Job Openings and Labor Turnover Survey (JOLTS) posted a 1.1 million decline to 10.1 million open jobs, the largest decline since April 2020 and another signal that the labor market may be coming more into balance.
The shortage of labor and subsequent wage inflation has been a source of persistent services inflation this year. Meanwhile, the very high job opening figure, with openings outstripping unemployed workers by 2-to-1 at its peak, has been another source of Fed concern. It's also another reason Fed Chair Jerome Powell thinks it's possible to have a "soft landing," or cooling inflation, without much unemployment, but rather just a cooling in job openings. Tuesday's data gives an optimistic picture that the JOLTS may now be coming down, and that higher interest rates are successfully cooling the economy.
Now what
The last two days have seen a nice rally in risk assets, but remember, in this market things can change very quickly. The fate of these three fintech stocks will largely be determined by if we have a recession, and if so, how bad the recession will be.
On the other hand, if you have confidence in any or all of these three companies' business models, management teams, and products, and that they would survive a recession, these names could have among the most upside of any stock in the market after their recent 80% to 95% fall from all-time highs. Perhaps you have used one or more of the loan products these companies sell. As famous investor Peter Lynch once said, the average person can outsmart Wall Street analysts if they are familiar with and use a product in their daily lives.
In any case, for those looking for the highest-upside stocks coming out of this downturn, I would definitely look at the fintech sector. It's been hammered the most, and if we do get a "soft landing" or just a mild recession, there are big gains to be had. Just be aware that risks still remain, especially if the economy gets as bad as some bears are forecasting.
