Interest rate cuts are great news for these two stocks, but terrible news for another

The Federal Reserve concluded its last monetary policy meeting on September 18 and its Federal Open Market Committee (FOMC) decided to increase the federal funds rate (the interest rate that commercial banks use when borrowing and borrowing money from each other overnight) by 50 basis points to lower points. That was double the 25 basis point adjustment the Fed normally uses, and it is expected to provide a tailwind for the economy by reducing borrowing costs for consumers and businesses.

According to the Fed’s own forecast, there could be another 50 basis point rate cut by the end of 2024, with further cuts possible in 2025. This is why such interest rate cuts are good news for stocks upstart (UPST -2.06%) And Redfin (RDFN 0.16%). It is also the reason Robinhood (HOOD -1.97%) Stock investors should be concerned.

Upstart: Falling interest rates could boost loan demand

Upstart has developed an artificial intelligence (AI)-based algorithm that the company uses to determine the creditworthiness of loan applicants and help originate loans for partner banks and credit unions for a fee. The company benefited from increasing demand for loans when interest rates were at historic lows in 2021, and that piqued investor interest, driving its stock price to a record high of $401 in fall 2021.

As part of an effort to control inflation, interest rates rose in 2022 and 2023 and the rate was at a 23-year high before the Fed’s recent rate cut. As a result, demand for loans collapsed and the risk appetite of Upstart’s banking partners decreased, meaning that Upstart had to finance some loans with its own money. This combination of headwinds created unacceptable risks in the eyes of investors, and Upstart’s stock price plunged to a low of just $13 in 2022.

When it became clear this year that the Fed would no longer raise interest rates, many of Upstart’s former financing partners returned to the platform. Two new contracts were even signed in the second quarter of 2024 (Ares Management and Centerbridge Partners). The company also issued 143,066 unsecured personal loans in the second quarter, up 34% from the same period last year, so demand for loans appears to be picking up again.

Analysts’ consensus forecast is for Upstart to generate revenue of $567.9 million in 2024, which would be flat compared to 2023 and still below its highest annual revenue of $907 million in 2022 would. However, analysts expect the company’s revenue to reach $725.9 million in 2025, an increase of 27.8%. That number could rise even higher depending on how aggressively the Fed cuts interest rates throughout the year.

Upstart has successfully navigated what was arguably the toughest environment for its company in its history. With favorable conditions on the horizon, now could be a good time to buy the stock.

Redfin: Lower interest rates should revive the housing market

Redfin operates a portfolio of real estate services, including brokerage, mortgage lending and closing services. The company was another victim of the rise in interest rates as it triggered a significant slowdown in the real estate market. According to the latest data, U.S. existing home sales are still about 41% below their recent peak set in 2021.

Simply put, high interest rates suppress the credit power of potential homebuyers and cause homeowners to shy away from selling for fear of giving up their existing lower fixed interest rate.

Redfin employs 1,719 principal agents, who accounted for 0.77% of all U.S. home sales in the second quarter of 2024. The company charges a listing fee of just 1%, which is well below the industry standard of around 3%. Redfin’s goal is to gain market share by closing a high volume of sales while saving sellers a lot of money in the process.

Redfin is on track to generate just over $1 billion in revenue this year, which would be a small increase compared to 2023. It will take time for falling interest rates to impact business, but the Fed is expected to continue cutting rates until 2026 (based on current forecasts), which would almost certainly reinvigorate the housing market.

Redfin shares are up 30% this year but are still 86% below their all-time high reached in 2021. As long as interest rates continue to fall, Redfin’s recovery will likely continue.

Robinhood: Falling interest rates could lead to falling revenue

Robinhood is a popular online brokerage platform (particularly among younger investors) and facilitates trading in stocks, options, cryptocurrencies, and other financial assets. There were 21.3 million monthly active users in the second quarter of 2021, but three years later that number has dropped to just 11.8 million in the second quarter of 2024.

Robinhood’s transaction revenue (which the company earns by processing customer trades) has followed a similar trajectory. Revenue was $327 million in the most recent quarter, up year-over-year but still well below its quarterly peak of $451 million from Q2 2021.

In other words, Robinhood’s core business has struggled to gain momentum in recent years, which is one of the main reasons the stock is trading about 72% below its all-time high.

Unlike Upstart and Redfin, it’s actually Robinhood benefits through higher interest rates. As of the second quarter of 2024, the company had $4.5 billion of its own cash and held an additional $4.5 billion on behalf of its customers. This money is stored in interest-bearing bank accounts. Robinhood’s margin lending book reached a record $5 billion in the second quarter, also a driver of interest income.

The company’s net interest income was a record $285 million in the second quarter of 2024 and has increased 319% since the second quarter of 2021. So essentially, rising interest rates have been the primary driver of Robinhood’s overall revenue growth over the last three years. This puts the company in a precarious position because if interest rates fall as expected in the next few years, its net interest income will decline.

Based on Robinhood’s results to date, it is unlikely that the company will generate enough growth in its core business to offset the decline in interest income. Investors who own the stock are therefore likely to face a difficult time in a falling interest rate environment.