What happened
Shares of fintech platform Upstart (UPST +3.23%) rose 20.1% on the week, as of 11:21 a.m. ET on Thursday, according to S&P Global Market Intelligence.
Upstart's bounce is certainly welcome for its suffering shareholders, which have seen the stock implode 96% from the all-time highs it set back in 2021 -- even factoring in this week's bounce.
Upstart is a platform that uses artificial intelligence to underwrite loans in a highly automated fashion, with a mission to reach borrowers "overlooked" by the traditional financial system. That concept sounds like a good one; however, the past year has exposed a big vulnerability in its business model: Upstart depends on third parties to buy its loans.
As inflation skyrocketed last year and the Federal Reserve rapidly raised interest rates, that revealed the vulnerability, as Upstart was forced to scale back underwriting and hold some loans on its own balance sheet, and profits flipped to losses. That wasn't what its investors had signed up for, and they fled the stock in droves.
While there wasn't any company-specific news this week, some encouraging macroeconomic data points increased hopes that the past year's inflation nightmare may be coming to an end. Even better, it looks like that may happen without significant job losses -- the elusive economic "soft landing."
NASDAQ: UPST
Key Data Points
So what
For Upstart, higher interest rates are bad, not only because it was a highly valued growth stock, but also because rapidly rising interest rates cause loan buyers to pull back on buying securities until they have more visibility on what their required return will be. In addition, most have feared that in order to quell inflation, the Federal Reserve may have to cause a recession, which also wouldn't be good for Upstart's customers' ability to pay back their loans. These double-sided risks are why the fintech sector sold off so hard last year.
Thus, when these fears reverse, so can Upstart's downward trajectory. Over the past week, incoming data has showed some very encouraging signs.
Last Friday, the December jobs report from the Bureau of Labor Statistics showed that the U.S. continued to add jobs at a moderating pace, increasing 223,000. Yet at the same time, wages only rose 0.3%, moderating from the too-hot gains seen over the past year.
Wage inflation is one of the elements the Federal Reserve fears, so to see employment and wages grow at a slower pace, even while increasing, was kind of a "Goldilocks" number. The hope is that the Federal Reserve can bring down too-high wage gains without causing mass unemployment, and December's data appeared to show the Fed is on the right track.
Then today's consumer price index report for December showed a -0.1% decrease in headline inflation and a 0.3% increase in "core" inflation, which strips out volatile food and energy prices. These numbers were in line with expectations and shows that inflation is definitely moderating.
Even if rates don't go all the way back down to where they were, which they probably won't, the mere prospect of stability in inflation and rates should be a positive for Upstart. Loan buyers may get some confidence and visibility into their own required hurdle rates for loans, which could bring more buyers back to Upstart's platform.
Meanwhile, easing inflation pressures without a bad recession would be a positive for loan performance, as borrowers would get some relief for prices while still maintaining their jobs. A 0.3% wage gain in December with a -0.1% decrease in inflation means workers' "real" wages increased 0.4% last month.
Now what
Upstart's beaten-down stock can no doubt have upside if the economic data continues to come in positively; however, the past year's troubles have exposed a clear vulnerability in its model. Some other fintech platforms have adapted to that vulnerability by acquiring a bank charter, getting deposits, and holding some or all loans on their balance sheets.
But Upstart's management has said they are not interested in that. On its August conference call, CFO Sanjay Datta said:
Banks are set up to be very robust and survive macro shocks... But as a result, those entities tend to struggle with a mission of trying to provide capital to Americans who are either less affluent or, through a traditional lens, less credit-worthy.
The quandary for investors here is if Upstart's mission may be in conflict with the best risk-adjusted financial returns for shareholders.
In addition, although this week's data was very positive for the prospects of a "soft landing," the global economy isn't out of the woods yet. Furthermore, one day there will be a recession, and if Upstart hasn't altered its business model by then, shareholders may be vulnerable to big swings in revenue and profits when that happens.
Personally, I think long-term investors would be better off playing the beaten-down fintech space with safer, more profitable companies, although Upstart could have a lot of near-term upsides if sentiment on the economy continues to flip from pessimistic to optimistic.
