Inflation has certainly started to cool off from the 40-year highs we saw in mid-2022, but they are still far greater than the Federal Reserve's 2% target. Most experts believe it will take a little longer for the Fed to get inflation under control with the current rate-hike cycle, but we're seeing signs that inflation might already be more controlled than it appears. For example, the month-over-month inflation rate was negative 0.1% in December and has been rather low in other recent months as well.
Clearly, if the Fed were to get inflation under control sooner than expected in 2023 and start lowering interest rates as a result, it would likely be a positive catalyst for stocks. But here are two in particular that could be especially big beneficiaries.
Falling rates could be a big catalyst for homebuilders
Inflation has been particularly rough on the homebuilding industry. Not only have housing costs skyrocketed, with the median new home price about 40% higher than pre-pandemic levels, but thanks to the Fed's interest rate hikes, mortgage interest rates have been trending upward over the past year. Some homebuilders have reported fourth-quarter contract cancellation rates of more than 65% as buyers are changing their minds.
Although Dream Finders Homes (DFH 2.53%) is one of the fastest-growing homebuilders in the United States, it hasn't been immune to market conditions. In the third quarter (the most recent quarter reported), Dream Finders' cancellation rate was 25.5% -- nearly double what it was a year before. And while the company ended the quarter with a backlog of 6,758 homes, that number should be taken with a big grain of salt, given the high fourth-quarter cancellations rivals are reporting.
NYSE: DFH
Key Data Points
If the Fed can successfully bring inflation under control in 2023, it would likely cause mortgage rates to continue cooling off, even if the central bank doesn't start cutting rates right away. While a large drop in housing prices isn't likely, if prices end up stabilizing and mortgage rates decline significantly in 2023, it could be a big catalyst for homebuilders. Dream Finders, in particular, could be a big winner as it focuses much of its efforts on entry-level homes (where there is a ton of pent-up demand) and some of the hottest and lowest-cost Sun Belt markets.
This banking disruptor could have a great 2023
Banking disruptor SoFi (SOFI 0.28%) has been growing at a breathtaking pace for several years now. That's especially true on the financial services side of its business, which includes things like checking and savings, brokerage, and credit card accounts. In the third quarter of 2022, SoFi's customers were using 5.9 million financial services products, an 83% year-over-year growth rate.
NASDAQ: SOFI
Key Data Points
There are a few reasons SoFi could be one of the biggest winners if inflation cools off. For one thing, lending demand is likely to pick up, which has been a bit sluggish for SoFi. If inflation drops, the Federal Reserve is likely to start cutting interest rates and a deep recession will become less likely, both of which are strong catalysts for loan demand.
Inflation and rising rates also make SoFi's cost of capital higher; the bank relies on borrowed money to fund some of its lending activities -- and to a greater extent than many rivals (for now). It has only been a bank for a short time, and its deposit base only covers about half of the loan portfolio.
While the financial services side of the business is the fastest growing, the lending business is the more profitable part. Although this has little to do with inflation, it's worth noting that SoFi's student loan refinance business (its original type of loan product) could come back in full force this year after three years of essentially no demand.
To be sure, lower inflation won't be completely good for SoFi. As a bank, interest margins are typically higher in rising-rate environments. But the positives (strong loan demand, lower defaults) are likely to outweigh moderate margin compression. Plus, keep in mind that falling inflation and interest rates are typically positive catalysts for high-growth stock valuations, and SoFi certainly fits into this category.
Great long-term investments
To be perfectly clear, I own both stocks in my portfolio as long-term investments, not because I necessarily think they'll have a great 2023. They could be big winners if inflation drops, but there's no guarantee that will happen in any given time frame, and macroeconomic factors are completely out of these companies' control.
However, both businesses are doing great with the things that are in their control. SoFi has done a fantastic job of building its banking customer base, which creates a natural (and long-tailed) marketing funnel for its profitable lending operations. Dream Finders' land-light business model gives it a competitive advantage by keeping capital requirements low. And the company has invested heavily in expanding its footprint into some of the markets with the best net migration, job growth, and wage growth in the United States.
So, while these stocks could be big 2023 winners if inflation is brought under control, I believe they'll be long-term winners even if the Fed's inflation fight takes longer than expected.
