What happened
Shares of fintech companies Block (SQ -2.28%), Nu Holdings (NU -1.69%), and Lemonade (LMND 0.83%) plunged today, down 7.5%, 3.6%, and 7.3%, respectively.
It was a terrible day for the markets, after this morning's inflation report came in hotter than expected. High inflation, as well as the likely aggressive Federal Reserve response, have been poison for the fintech sector this year, which has seen some of the worst sell-offs of any sector in the market. Today saw an unfortunate continuation of those trends.
So what
Fintech stocks have been some of the hardest-hit in this environment, in which high inflation has been coupled with fears over a recession.
Since these upstart fintech names are high-growth stocks that are plowing everything they earn (and more) back into their businesses, each of these companies is registering a loss right now on a GAAP basis. So higher interest rates will tend to affect the stocks heavily, as the further out future earnings are, the more they are discounted to a lower present value.
All growth stocks suffer that fate, but the problem with fintech stocks is two-sided; the other side is that higher inflation gives rise to the fear that the Federal Reserve will have to spark a recession through higher interest rates, and a recession would also be bad for all financial stocks that lend money.
While Block and Nu Holdings do make a fair amount of their revenue from fee-based streams like payment processing, they both also have a loan book. When rates rise, the value of current fixed-rate loans goes down, and the potential for higher delinquencies and defaults goes up.
For Block specifically, its focus on Bitcoin (BTC -0.87%) might also be biting today, as the price of the cryptocurrency is down 9.6% in the past 24 hours as well. Block has made a big play on crypto trading, and even holds some Bitcoin on its balance sheet. Some investors had thought Bitcoin might act as a hedge against inflation, but so far, it seems to be trading in line with technology stocks and other speculative assets, which are declining as inflation rises.
Lemonade's disruptive insurance products could also see pressure, because the company has been dogged by a rising gross-loss ratio. With inflation remaining high, the costs for claims could continue to go up. Though management has made adjustments to pricing in response to higher costs, that could also be a detriment to customer acquisition, which isn't great for a high-growth stock.
Now what
New-age digital banks as well as other finance-related stocks like Lemonade are likely to be viewed with more skepticism by dyed-in-the-wool financial investors, who are more likely to favor old-school, highly regulated large-cap banks.
Unfortunately, companies that have been untested by an inflationary crisis thus far -- and are experimenting with new assets such as Bitcoin, as Block is doing, or trying out a brand-new business model, as Lemonade is doing -- are likely to be shunned in a risk-off environment until they prove themselves. In this environment, that means showing that their underwriting can correctly price the risks on their balance sheets, and making it through a recession without a disaster. Unfortunately, that might have to play out before these stocks get more credit.
Fintech stocks were some of the darlings of the low-rate pandemic environment, as customers gravitated toward digital solutions, contact-less payments, and cryptocurrencies. But those trends are reversing in a big way, and it will likely take inflation coming down and recession fears subsiding for these stocks to continue higher.
In fact, Nu Holdings was upgraded last week on the premise that its high funding costs would be subsiding with lower inflation. But with today's disappointing inflation report, it looks as if investors will have to wait a little longer for that to happen.
