To The Moon

By Bram Berkowitz

KEY POINTS

• More data confirmed that inflation stayed high in May.
• The Federal Reserve is likely to keep raising interest rates.
• Rising rates have crushed several of these fintech stocks.

Investors continue to sell stocks as we head into a murky environment.

What happened

Several fintech stocks continued to fall as the Federal Reserve's preferred gauge of inflation confirmed that consumer prices and inflation stayed hot in May.

Shares of the buy now, pay later company Affirm($Affirm Holdings, Inc.(AFRM)$ )are trading nearly 6.5% lower as of 10:34 a.m. ET today. Shares of the artificial intelligence lenderUpstart($Upstart Holdings, Inc.(UPST)$ )are trading roughly 3.4% lower, and shares of the Brazilian digital bankNu Holdings($Nu Holdings Ltd.(NU)$ )are down nearly 4.7%.

So what

Core personal consumption expenditures, which are tracked by the U.S. Commerce Department and watched closely by the Fed, showed that prices rose 4.7% in May from the same month in 2021. That actually was slightly less than the Street had been projecting but still not enough to provide any relief to stocks this morning.

"The rising cost of living absorbed all of the increased spending power from added jobs and higher wages in May," said Comerica's chief economist, Bill Adams. "Americans are running faster just to stay even. No wonder consumer confidence is in the pits."

The longer inflation persists, the worse it will likely be for stocks like Affirm, Upstart, and Nu Holdings. The Fed will likely have to stay aggressive and keep raising interest rates until it can get inflation to flatline and then start to fall.

Rising rates have been devastating for Affirm and Upstart because they increase the likelihood of loan defaults, which requires investors buying loans from Affirm and Upstart to request higher returns for taking on the risk. As a result, these two firms could have to keep raising loan pricing on their platforms, which would slow origination volume and hurt revenue. The even bigger risk is that demand for these loans from investors might dry up dramatically and really hamper growth. Both stocks have been the subject of analyst downgrades this week.

Morgan Stanley analyst James Faucette recently lowered Upstart from an "Equalweight" rating to "Underweight," citing rising rates and lower loan demand.

"Credit performance and interest rate tailwinds from '21 are rapidly shifting to headwinds in '22, impairing institutional funding supply," he wrote in a research note.

Piper Sandler analyst Kevin Barker recently maintained his "neutral" rating on Affirm but cut his price target from $32 to $28, largely as investors and the rest of the market prepare for a recession, which could have tough implications for the consumer finance sector. Last October, shares of Upstart hit $390 per share (currently $30.50) and shares of Affirm reached $168 (currently below $18).

Now what

While the sharp decline in share prices has made Affirm and Upstart much more attractive, there are likely more rate hikes coming and a potential recession, which could continue to put downward pressure on both of thesefintechbusiness models.

Although both stocks have tremendous potential, investors are likely to be less interested if the businesses cannot prove to be sustainable through the rate cycle, which is why I am not interested in either stock right now.

Nu is also a consumer-facing company, being a large digital bank in Brazil, but I am much more optimistic about this stock, which has completely disrupted the Brazilian banking landscape. Not only does Nu have access to customer deposits, but it also seeks to have the primary banking relationship with each of its customers. If it succeeds, it may be able to grow revenue per customer and serve its customers better, providing more resilience for the model.

Resource: the Motley Fool