What happened
Shares of many technology and fintech stocks struggled this week, largely due to the release of the Federal Reserve's December minutes.
Shares of Cathie Wood's Ark Innovation ETF (ARKK -2.12%) had fallen nearly 10% for the week as of market close Thursday, while shares of buy now, pay later (BNPL) company Affirm (AFRM -0.45%) were down roughly 19%. Shares of the artificial intelligence lender Upstart Holdings (UPST -1.97%) and digital banking app SoFi Technologies (SOFI -0.28%) had fallen more than 21% and nearly 13%, respectively, for the week.
So what
There does not seem to be a ton of company-specific news related to any of these stocks or exchange-traded funds. Rather, they are reacting to macro news and the new direction of the Federal Reserve, similarly to the way they have over the past few months.
It's hard to believe, but earlier this year many believed the Federal Reserve would not look to raise its benchmark overnight lending rate, the federal funds rate, until 2023, and maybe not even until 2024. But that quickly changed as inflation surged and the Fed finally retired the word "transitory" when talking about inflation. Toward the end of 2021, the Fed began to indicate that it would taper and end the bond-buying program it began at the beginning of the pandemic. The Fed is also indicating it could raise interest rates in March, and the new surprise from the December minutes is that the Fed could start to actually shrink its balance sheet after the first rate hike begins.
Image source: Getty Images.
When the Fed moves to shrink its balance sheet, unlike the bond buying it has been doing, which is also known as quantitative easing, it will actually be removing liquidity and reducing the country's money supply, which can make the stock market a tough place to be.
"The minutes showed the FOMC [Federal Open Market Committee] is coalescing around the view the economy is ready for a broad-based removal of monetary accommodation, and the omicron variant is unlikely to slow it down," Bloomberg's chief U.S. economist Anna Wong said in a research note. "We think the risk of rate liftoff at the March meeting has increased substantially and will be watching closely Fedspeak ahead of the January meeting for further indications."
Since the release of the Fed's December minutes, longer-term bond yields have been marching higher. The yield on the U.S. 10-year Treasury bill has grown to 1.73%, up from just over 1.5% at the end of 2021. Rising bond yields are typically bad for tech and growth stocks because they offer investors higher yield on risk-free assets, which makes high valuations difficult to support. Stocks like Upstart and Affirm had risen to massive valuations in 2021. The Ark Innovation ETF is filled with high-growth tech stocks like Tesla, Roku, and Zoom Video Communications. SoFi had reached a pretty large valuation in 2021 as well.
Now what
Many of these tech and fintech stocks have great potential as they are disruptors in their perspective industries. But I thought stocks like Upstart and Affirm had risen way too high and way too quickly in 2021, so I think a pullback was due.
Now, valuations are better but there could still be difficult market conditions for 2022, as the Fed has yet to do its first rate hike or begin running off its balance sheet yet. If SoFi can obtain its anticipated bank charter, that could help the company a little bit because banks are typically more of a hedge against inflation.
I'm a little more worried about Affirm right now because of the regulatory scrutiny around BNPL and potential credit issues in a higher-rate environment. I still like many tech and fintech stocks long-term but think it is appropriate for valuations to get more in line with reality right now.
