Why Coinbase, Upstart, and Nu Holdings Fell Today – The Motley Fool | Jewelry Dukan

What happened

Shares of three recently listed fintechs – cryptocurrency platform coin base (COIN -8.88%)AI based lending platform upstart (UPST -5.94%)and Brazilian digital bank Nu stocks (NO -1.61%) — all down 8.2%, 6.5% and 1.9% respectively as of 12:30 p.m. EDT on Monday.

The Federal Reserve raised interest rates to tame inflation and accelerated its quantitative tightening on September 15th. That means it’s rolling many government bonds and mortgage-backed securities off its balance sheet. This should lead to higher longer-term interest rates as these securities now need to be priced attractively for private sector buyers. In fact, the 10-year Treasury yield hit 3.5% earlier today, briefly surpassing its June highs.

A popular thesis has been that higher interest rates would benefit financial stocks because they could earn more net interest income from higher lending rates. However, what we’re seeing with these three fintech stocks is actually the opposite. Here’s why.

so what

As a cryptocurrency broker, Coinbase earns most of its revenue from cryptocurrency trading. Therefore, when cryptocurrency asset prices fall, they are severely affected. And when there is a crypto bear market like the one we are in right now, scared traders tend to back off trades while waiting for things to change. With that in mind, it’s no wonder Coinbase is down again today.

Some thoughts Bitcoin (BTC -3.34%) protection against inflation, but this turned out not to be the case in the past year of inflation. Bitcoin prices are actually down about 70% since last fall when inflation swept the economy. Bitcoin prices fell sharply in early trading today before recovering to a milder loss. Unsurprisingly, Coinbase shares traded lower on sympathy.

What exactly happened to the bitcoin-as-inflation hedge thesis? It can be due to several factors. First, even though Bitcoin is over a decade old, cryptocurrencies are still a new asset class. Additionally, cryptocurrencies don’t yield cash in the form of dividends or buybacks like other stocks and bonds do. So when liquidity is drained from the system, many investors — particularly older investors — may need cash now and may not be able to hold securities that don’t pay dividends or interest income.

The same fate befalls all growth stocks that don’t pay dividends, including Upstart and Nu Holdings.

Nu is also affected by higher US interest rates, but for a different reason. Nu is an emerging digital bank with offices in Brazil, Colombia and Mexico. Rising interest rates in the US could strengthen the dollar against other world currencies, a trend that will continue throughout 2022. If the dollar strengthens, that means Nu’s earnings and profits would be worth less to U.S. investors in those other currencies.

Additionally, Nu Holdings is a very high growth stock that reinvests in growth and has no ongoing earnings. Overall results have been quite strong recently, with sales up 230% in local currencies. That’s probably why it fell less than the other stocks.

However, longer-duration investments like growth stocks also tend to be hit harder than other stocks when long-term interest rates rise, as higher yields translate into higher discount rates on future earnings. So the further into the future the profits lie, the less they are worth in cash today. So, as a high-growth stock, Nu was not spared despite strong results.

This phenomenon also affects Upstart, another growth stock. Upstart actually made a profit over the last 12 months, but revenue fell and the company went from a $37 million net income gain in the year-ago quarter to a net loss of $30 million in the second quarter of 2022.

Upstart is a unique case where rising interest rates have actually put pressure on the underlying business model. Upstart positioned itself as a lending-only platform, launching this year: It would sell its loans to third parties and then recycle the money into more growth. However, soaring rates this year have caused loan buyers to slow or pause their purchases. Of course, when rates are going much higher, these buyers don’t want to be stuck with a lower-rate loan that has lost value.

As a result, Upstart has had to slow its lending and has even started to hold more loans on its own balance sheet. This increases the company’s risk should these loans default. These compounding issues are why Upstart tends to crash when interest rate concerns come to the fore.

What now

The current risk-off sentiment amid rising interest rates generally means investors are avoiding “risky” assets. Unfortunately, that means nearly every fintech stock slams even more than the average stock.

Fintech stocks have a bad combination of duration risk, as most are profitless or underperforming growth stocks, and underwriting risk, as they also lend. Even Coinbase makes loans against its customers’ crypto assets, although it claims it hasn’t lost any money on its customer funding activities.

But just as rising interest rates have hit these types of stocks, a trend reversal could reignite them. If inflation starts to ease and the Federal Reserve stops tightening conditions, these stocks could well have significant upside potential given their fall over the past year.

However, it’s hard to say when these trends might reverse, and this fintech bear market could last for some time. That said, those looking to aggressively position themselves for a market recovery — perhaps younger growth investors — should definitely consider the fintech sector.

If you want to bet on a sector recovery, you’ll want to make sure that any fintech stock you choose has conservative leverage and will weather the current downturn, and that it’s well-positioned to recover relative to peers .

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