We’re all too familiar with this month’s catchphrase – “higher for longer.” The Fed’s promise to keep rates up through (potentially) 2026 spooked investors, and markets reacted accordingly. The S&P 500 fell by almost 5% since the announcement, but more pain could be ahead.
Higher rates pose a risk to stocks on two primary tenets. First, capital structuring usually demands companies hold a certain amount of debt. Unprofitable, growth-centric companies (like tech stocks) usually depend most on debt. Rising rates mean their borrowing costs are higher and lead to default risk.
At the same time, higher rates mean that fixed-income assets generate greater returns than usual. Stocks are inherently riskier than bonds, CDs, and savings accounts – if investors can get higher yields for reduced risk, moving cash out of stocks is a no-brainer.
To that end, these three stocks stand to lose the most as rates stay higher for longer.
Workiva (WK)
Workiva (NYSE:WK) operates as a specialized software company focused on financial reporting, ESG audit, and risk management solutions. While the stock experienced significant growth this year, posting a remarkable 20% surge, elevated interest rates and its financial positioning warrant a second look at this stock.
In the second quarter of 2023, Workiva reported total revenue amounting to $155.0 million, signifying an 18% increase compared to the corresponding period in 2022. However, there are looming concerns as the company grapples with mounting debt and cash flow issues.
Most notably, Workiva finds itself where its short-term liabilities nearly match or exceed its current cash and receivables balance. As the costs of servicing this debt continue to rise, it poses a considerable risk to the company’s financial stability.
The risk becomes evident when examining Workiva’s interest coverage ratio, which measures a firm’s ability to meet interest expenses solely from earnings. Workiva’s interest coverage ratio is a concerning -16.91, indicating that the firm cannot cover its existing debt obligations with earnings alone.
While this capital structure might have been sustainable in an era of readily available credit, the current landscape of financial prudence places this stock in jeopardy of potential default amid higher rates.
iShares 20 Plus Year Treasury Bond ETF (TLT)
Although some bond ETFs benefit from higher interest rates, iShares 20 Plus Year Treasury Bond ETF (NASDAQ:TLT) isn’t one. Remember that bond prices fall as yields rise, and yield increases are largely driven by investor sentiment based on current rates. So, rising rates mean that bond prices – and ETF prices fall, too.
TLT is already at a decade-long low, and there could be further downside soon. Higher rates for longer will keep downward pressure on longer-dated bond pricing. TLT is a typical stand-in for retail investors who shy away from directly buying bonds and move alongside broad bond markets accordingly.
Indeed, TLT’s recent drawdown is its biggest on record. Despite the evident risk, bullish investors are flooding into the ETF. The ETF has seen more than $15 billion added to the fund this year. That inflow is likely based on the hope that rate cuts or pauses cause a bond rally. While possible, that isn’t a likely scenario for the foreseeable future.
Despite the suppressed share price, the upside to investing in TLT is that it offers a monthly interest payment distribution. The fund also has a low 0.15% expense ratio which lets you keep a higher percentage of your investment.
TLT currently yields a bit more than 3%. If you reinvest the distributions, you can lower your cost basis and position yourself for a bond rally – but that might be a long time coming.
Upstart Holdings (UPST)
Upstart Holdings (NASDAQ:UPST) finds itself in a challenging position with a streak of declining performance, and looming economic concerns do not bode well for its struggling share price. In July, the stock peaked, benefiting from the momentum generated by the surging popularity of artificial intelligence (AI). Much of Upstart’s business revolves around AI-driven analytics, particularly in private lending.
However, Upstart’s core value proposition lies in providing loans to individuals who may struggle to secure financing through traditional channels. This characteristic places the stock in a precarious position, especially when interest rates remain higher for longer. This prolonged period of elevated interest rates not only escalates the company’s cost of debt but also heightens the risk of defaults among its borrowers.
Presently, Upstart’s personal loan interest rates can go as high as 35.99%, and there is potential for them to climb even further as the company grapples with its rising borrowing costs. Meanwhile, consumer loan defaults are increasing, approaching levels not seen in nearly a decade. Concurrently, consumer credit card debt has reached an all-time high. The combination of substantial debt burdens, soaring interest rates, and increasing consumer defaults presents a daunting challenge that could crush this stock.
On the date of publication, Jeremy Flint held no positions in the securities mentioned. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
