Why Fintech stocks Upstart, SoFi and Affirm flew today

What happened

Shares in fintech companies Upstart (UPDATE 5.64%), SoFi technologies (SOFI 3.35%)and Confirm (AFRM 6.55%) were on the rise today, up 6.1%, 3.7% and 7.9%, respectively, as of 3:36 PM ET.

These three stocks are down sharply this year and are rising from their all-time lows, so a big daily rally is not surprising. The question is, do the current reasons for their rise indicate a bottom, or just a dead cat bounce?

So what

Today’s rally seems to be about interest rates.

First, some context. Fintech stocks like these three have been some of the worst performers over the past year. Therefore, if the trends that caused the pullback reverse, there’s a reason why fintech stocks could rally harder to come out of this — that is, if these companies make it through a potential recession.

The fall in this sector is due to two negative trends working together. First, these forward-thinking companies have set their sights on disrupting traditional finance, so they spent heavily on growth, innovation and customer acquisition, while either making very little or burning money outright.

Unprofitable growth stocks have had a very difficult time ever since inflation and interest rates rose towards the end of last year. This is because higher long-term interest rates lower the present value of future profits, all other things being equal. Given that these stocks have pretty much all of their potential profitability well into the future, that hurts valuations.

But fintech stocks are also vulnerable in another way, as the Federal Reserve raises interest rates to tame inflation. That’s because many believe the Fed must induce a recession to get inflation back under control. Although not certain, history does not offer particularly favorable odds for a “soft landing,” in which inflation declines without a recession.

Since these fintech companies, particularly Upstart and Affirm, are perceived to lend to less creditworthy borrowers, some fear that write-offs will also hurt earnings and potentially jeopardize these companies’ liquidity.

Upstart uses artificial intelligence to guarantee loans to borrowers who may have undervalued FICO scores or otherwise will be denied loans they should qualify for – at least in the upstart’s eyes.

Upstart’s models showed higher-than-expected installments earlier this year, as the 2021 vintages were signed before inflation rocketed higher unexpectedly. Management has maintained that it has adjusted its models to fit the new environment, but investors appear to have lost faith and remain skeptical. The shares are down a whopping 94% from their records.

Affirm is a pioneer in the “buy now, pay later” space, which has also drawn much investor skepticism. Since these offers tend to help cash-strapped consumers pay off big-ticket items over time, some suspect they’ll see a lot of defaults if unemployment rises.

SoFi caters to more affluent borrowers, as the company targets students with student loans and then sells them more financial products over time. However, the company is currently unprofitable on a GAAP basis, having lost $387 million over the past 12 months. So while it should have a better borrower base, investors are currently worried about how to value this money-losing stock.

So why are these stocks bouncing today? With higher inflation and interest rates both causing concern, today’s easing of long-term rates from recent highs is likely to lead to the big gains. After hitting a 4% yield, the highest in more than a decade, the 10-year Treasury bond yield fell sharply today, falling from 4% to 3.73% at the time of writing.

That’s a big relief for growth stocks in general, including fintech stocks like these three.

What now

While still containing a fair amount of risk, these three stocks are down tremendously from their all-time highs. Therefore, should these three make it through a potential recession, or if the economy avoids a recession, the upside could be very large.

Those looking for bargains should dig into each company’s business model, balance sheet and management to assess for themselves. If you gain confidence that the company has what it takes to make it through even an adverse recession, this type of stock may have the biggest upside coming out of this period.

Just be aware that these are still young companies that are only suitable for growth-oriented investors. Older investors who can’t afford volatility should probably stick with more established, high-quality blue chips that pay out consistent dividends.