Why Charles Schwab is rising today

Stocks of the big broker Charles Schwab (SCHW 2.46%) traded as much as 3.2% higher after the company reported a business update this morning, indicating that third-quarter results were trending in line with expectations. The company also saw good net new asset growth.

Good trends in the third quarter

Schwab reported net new asset growth of $32.8 billion in August, $4.9 billion more than in August 2023. August also included expected attrition ahead of a conversion weekend of customers in September, the largest transition weekend of five held throughout the year.

Trading cash (client funds yet to be invested) fell by several billion from $371.8 billion in July to $366.8 billion in August, a significant improvement over August 2023 and 2022. Schwab struggled in the rate environment of high interest rates as customers moved their cash transfers into higher yielding financial instruments. Bank deposits fell by about 17.5% year-on-year in June.

Schwab is also likely to benefit this morning as several traders bet on the Federal Reserve cutting interest rates by half a point when it concludes its meeting on Wednesday. Not only would this help with the cash-sorting problems Schwab has experienced in recent years, but the company is also taking billions in unrealized securities losses from investing in lower-yielding, longer-dated securities before rising interest rates. They will recover their value faster if interest rates start to fall.

Is the stock a buy?

In a lower-rate environment, Schwab should benefit from less pressure on its overall balances — and potential upside, too. As the company recovers paper losses from the securities book, equity will improve.

In the unlikely scenario that inflation resurfaces and the Fed has to hike again, or if it doesn’t cut interest rates as much as expected, Schwab could face more cash-sorting problems. The bank also plans to use a new strategy given what just happened in the rate hike cycle, so it may not have the earning power it once had.

Finally, I think it’s okay for investors to dip their toes in the water because there is a paper loss recovery trade in the portfolio of securities and therefore stocks. But I would wait for more clarity on the strategic path before making this a significant position in your portfolio.