After a long wait, investors finally got the rate cut they've been looking for.
The Federal Open Market Committee (FOMC) cut the Fed funds rate by 25 basis points to 4% to 4.25%, its first rate cut of the year. In comments addressing the move, Federal Reserve Chair Jerome Powell explained that the downside risk in the labor market had grown, meaning the rate cut was done to help support the job market, in line with the central bank's stated goal of maximum employment.
But the rate cut, which was widely anticipated, wasn't the only news. The Fed also got more dovish with its future forecast. According to the "dot plot" projections, the committee expects two more rate cuts this year, calling for one more than it did in June, its last projection. It expects another rate cut next year and sees the Fed funds rate settling at 3% over the long term.
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Investors weren't quite sure what to make of the news. The S&P 500 index initially popped on the announcement, but quickly gave up those gains. It then lost roughly 1% during Chair Powell's press conference before recovering those losses toward the end of his remarks. The broad market finished nearly flat, down 0.1% for the session.
It's unclear where the stock market will go from here if rates come down over the remainder of the year as the Fed predicts. The market may have already priced in those rate cuts, given the signaling from the Fed in recent weeks and the weakening labor market.
However, there is one stock that looks like a good buy in a falling-rate environment.
Why Upstart looks like a winner
Upstart (UPST -5.82%), an artificial intelligence (AI)-based consumer loan originator, followed the same fluctuation as the S&P 500, but finished Wednesday's session up 1.4%.
Upstart is one of a number of stocks that benefit from lower interest rates. Demand for loans goes up as rates go down, and approval rates tend to go up as well, as interest payments become less burdensome.
In 2021, when rates were near zero, Upstart was delivering blockbuster growth and strong profits. As rates rose in 2022, that growth and profitability disappeared, and the stock plunged. Since then, despite rates remaining elevated, Upstart has rebuilt its business, improving its AI model, finding new partners to buy its loans, and streamlining the business to get back to profitability. It's also moved into auto and home loans, two massive lending markets, and it's seeing triple-digit percentage growth in those categories, though on a small base.
Upstart's second-quarter results show the business is on fire, with revenue up 102% year over year to $257 million. It has a generally accepted accounting principles (GAAP) profit of $5.6 million, up from a loss of $54.5 million in the quarter a year ago.
In its Q2 earnings call, management said it wasn't planning for any interest rate cuts in the second half of the year, even as its guidance called for strong growth to continue on the top and bottom lines.
What rate cuts mean for Upstart
Upstart's business isn't going to get back to 2021 levels anytime soon, but it doesn't need to for the stock to be a success.
The company is competing in a multi-trillion-dollar addressable market as it expands to home and auto loans, and it only owns a sliver of that market. Falling interest rates will be a tailwind for the business. It's ready to capitalize on that as it continues to improve its model, which it claims is significantly better at measuring credit risk than the FICO score.
Lower interest rates mean that Upstart's addressable market will get even bigger. At a market cap of less than $7 billion, there's still a lot of upside potential for the stock.
