As the COVID-19 pandemic begins to recede in the United States and the economy begins to reopen, asset shortages and high government spending are causing inflation to rise in some areas. Gradual price increases over time are actually a good thing. It is the sign of a healthy economy. However, after more than a decade of too cold inflation (less than 2% per year), there are growing fears that the rate will reach unhealthy levels as consumer and business spending accelerates this year.
For the record, I think this will be a transitory problem and high inflation will subside in a year or two as the pandemic subsides. Nonetheless, it never hurts to have your wallet ready for all kinds of conditions. That’s why I loaded myself PayPal funds (NASDAQ: PYPL), Square (NYSE: SQ), SVB Financial Group (NASDAQ: SIVB), SoFi (Share capital Hedosophia Holdings V (NYSE: IPOE)), and Upstart Holdings (NASDAQ: UPST).
Increased traffic passing through the toll
Digital payments could be one of the main beneficiaries of inflationary forces. In addition to a general secular trend favoring digital and online transactions over cash, higher prices for consumers and businesses translate into increased revenues and profitability for these businesses. Since digital payment platforms act like a toll that charges fees for processing transactions on their network, higher volume equates to higher tolls for these businesses. PayPal and Square are my two top picks in this area.
For PayPal, a recovery in consumer activity signifies a continuation of the fantastic growth rates it posted in 2020. In fact, management has provided prospects for an increase in total payment volume (TPV) of approximately 30% this year in addition to the growth rate of 31%. since last year. This should result in revenue growth of around 20%, and since PayPal has already built its core network, most of those gains will go straight to the bottom line. For reference, PayPal’s free cash flow grew 48% last year to $ 4.99 billion on revenue growth of 22%. In other words, inflation is hardly a concern for PayPal at this point. Expect another year of rapid expansion.
While PayPal has benefited from a rapid increase in online spending, Square’s core business has been hit hard in 2020 as it relies heavily on in-person spending in small and medium businesses. But this basic segment is starting to rally. Transaction-based revenue grew 27% year-over-year in the first quarter and is poised to start recording depressed quarterly financial figures compared to last spring at the start of the pandemic. Its peer-to-peer Cash App money movement service stood out in the last quarterly update. Revenue from the Cash application (excluding Bitcoin) was up 139% from a year ago in Q1 to $ 529 million.
Speaking of Bitcoin and cryptocurrencies in general, PayPal and Square both allow crypto trading, through Venmo and Cash App, respectively. If cryptocurrencies continue to gain traction as a payment method, both could become the best apps to ease their movement. After all, cryptocurrencies were designed to be a semi-decentralized payment network that cuts out middlemen, like banks, to lower transaction fees for businesses and consumers. Additionally, some investors are starting to view Bitcoin as a type of “digital gold” because there is a finite number of Bitcoins that can ever exist, and it is used as an inflation hedge in some wallets. Square has a significant Bitcoin horde on its balance sheet and will benefit greatly if the price of Bitcoin rises over time – either because of inflation fears or as a growing form of online payment.
Bet on better banking services and loans
When inflation is accelerating, bank stocks are the first choice. Case in point: After a difficult 2020, the total return of the Dow Jones US Bank Index is up almost 35% this year at Monday’s closing price. SVB Financial Group and SoFi – soon to go public through special purpose acquisition company Social Capital Hedosophia Holdings V – are my two favorite bank picks.
Why bank stocks? As inflation rises, so do inflation expectations – as is usually the case during periods of economic recovery – interest rates tend to follow. This situation can lead to a widening of the difference between short and long term interest rates. The steepening of the yield curve is great news for lenders, as it means an increasing margin between what it distributes in cash on deposit and what it lends to borrowers, i.e. short term versus long term. SVB Financial, better known as the parent company of Silicon Valley Bank, lends specifically to tech and healthcare start-ups and venture capitalists. It has a growing customer base and a lot of equity in fast growing technology companies, creating a double windfall for this traditional bank. Interest income increased 11.5% in the first quarter, contributing to a 37% year-over-year increase in net income in the first quarter.
SoFi is a nontraditional digital bank, and as a lender – it has started offering personal loans – it could also benefit if inflation helps improve interest rates in its favor. But it’s also a story of growth, and SoFi is in the early chapters of its journey. Total membership increased 121% from a year ago at the end of March 2021 to 3.19 million. Adjusted net income also beat the company’s own guidance by as much as $ 195 million in the first quarter, to $ 216 million, up 151% from a year ago. Such growth will easily put an end to worries about inflation.
Then there is Upstart, which in itself is not a bank. Although it does make a few loans here and there directly to borrowers, most of its income comes from partner banks and other lenders who subscribe to its artificial intelligence service. Upstart’s platform automates the lending process, and its non-traditional data collection helps banks issue more loans at a lower rate of loss. It’s a win-win situation as banks look for new ways to attract customers and increase their profits. For now, Upstart helps with personal and auto loans, but has an eye on other areas of the consumer credit industry. If inflation rises at a moderate pace, this tech company and its banking partners will be big winners. Upstart forecasts revenue growth of around 158% this year.
Rising prices for goods and services are not really acceptable when it comes to paying the bills, but inflation is no death knell for investing. On the contrary, moderate inflation is a sign of a healthy economy and could provide a positive wind for digital payments and bank stocks this year.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.