What happened
After two days of strong gains, Wall Street appeared to be taking a breather on Wednesday, with a broad cross-section of stocks losing ground. Investors seemed to ponder the wider economic landscape, looking for signs of what the future might hold.
With this as a backdrop, a number of financial technology (fintech) companies traded lower, as Upstart Holdings (UPST -1.25%) tumbled as much as 10.3%, Affirm Holdings (AFRM -1.34%) slumped as much as 9.4%, and SoFi Technologies (SOFI -0.13%) slipped as much as 5%. As of 1:36 p.m. ET today, the three were still trading lower, down 9.7%, 9.1%, and 4.6%, respectively.
To be clear, there was no company-specific news fueling the declines. Rather, investors grew more cautious after reading the latest economic tea leaves.
Image source: Getty Images.
So what
The major market indexes rallied for two successive days to start the week, boosting a wide range of stocks. Both the S&P 500 and the Nasdaq Composite surged, up 4.4% and 3.8%, respectively, through Tuesday.
The catalyst for the gains were economic developments in the U.K., which rolled back a number of ill-timed and hastily issued tax cuts -- announced just weeks ago -- that roiled financial markets and called into question the country's financial stability.
But the earlier optimism gave way to caution as investors pondered the latest economic indicators, which weren't nearly as rosy.
The U.K. reported that inflation returned to a 40-year high, up 10.1% year over year in September, climbing from 9.9% in August. The biggest contributor to the gains were surging food prices, mirroring the situation in the U.S.
At the same time, new-home building lost ground last month, declining 8.1% compared to August, and dropping 7.7% compared to the same time last year. Potential homebuyers were spooked by rising mortgage rates, which made new homes significantly less affordable.
Lastly, credit rating agency Fitch warned that persistent inflation and the Federal Reserve's continued rate hikes could slow economic growth and push the economy into a recession. It's important to note that Fitch still expects U.S. gross domestic product (GDP) to grow by 0.5% in 2023, while also saying, "The U.S. recession we expect is quite mild."
The general takeaway from these macroeconomic puzzle pieces is that the recovery will take time and the economy could remain in a trough for a while longer. For those playing the long game, however, this is merely a day like many others.
Now what
The Federal Reserve has been very up front about its plans to aggressively fight rising inflation, calling it the biggest threat to the global financial system. In fact, the Fed has signaled that rate hikes will likely continue well into next year. Unfortunately, this ongoing campaign to fight inflation makes borrowing more expensive and could eventually result in job losses and a corresponding recession.
On the whole, financial institutions benefit from higher interest rates. They can leverage the spread between the rate at which they lend money and the rate they pay depositors, since higher interest rates tend to increase the spread. That could benefit fintech companies like SoFi, which provides a vast array of financial products and services to consumers, and Upstart, which uses its artificial-intelligence-fueled platform to help lenders better determine the creditworthiness of higher-risk borrowers.
However, a drawn-out economic downturn will hurt consumers at the lower end of the financial spectrum much worse, making it more difficult for them to meet their financial obligations, resulting in higher loan defaults and write-offs. This will ultimately hurt buy now, pay later (BNPL) lenders like Affirm, while also weighing on SoFi and the financial institutions that use Upstart's technology.
Given the challenges that remain, it's easy to understand why investors are cautious about these fintech stocks, as they are reminded that the overall recovery could take some time.
That said, there's an upside for investors with the financial resources and ability to stomach continued volatility. Upstart, Affirm, and SoFi stocks have been absolutely punished during the bear market, losing 94%, 89%, and 76% of their value, respectively. As a result, the trio are currently selling at their lowest valuations ever, at roughly 2 times next year's sales. For context, a reasonable price-to-sales ratio is between 1 and 2, putting these stocks squarely in bargain basement territory.
Given the higher interest rate environment, I think Upstart and Affirm are both inherently riskier propositions then SoFi, whose customers generally have a lower credit risk, making it my clear favorite of the three.
