It Was A Sweet Ride While It Lasted

For the brokerage industry, the first three months of 1993 was a quarter to die for. Merrill Lynch & Co.'s earnings jumped 57%, to a phenomenal $342 million; Bear, Stearns & Co.'s profits were up 21%, to $110.4 million; and Charles Schwab & Co.'s profits rose 19%, to $35.4 million--all personal bests. But for the rest of the year, it's likely to be downhill for brokerage earnings and their earnings-driven stocks. "I think we have seen a peak in the first quarter now for three years in a row," says Sanford C. Bernstein analyst Guy Moszkowski. "The quarter-to-quarter momentum is just not there."

Moszkowski is putting his money where his mouth is. The only pure brokerage stock he is recommending is Salomon Inc., which he believes is undervalued due to trading losses in the first quarter. Lehman Brothers analyst Dean Eberling also thinks some brokers are getting pricey. He just removed Morgan Stanley & Co. from his buy list, while downgrading Bear Stearns and Charles Schwab to "neutral" and "underperform." Brokerage stocks have already sold off since first-quarter earnings announcements, with Schwab falling 16% since reporting record profits on Apr. 15.

MONEY SWITCH. It was a nice run while it lasted. Merrill's stock has more than tripled since 1991 (table), delighting the firm's biggest shareholder, Denver-based Janus Capital Corp., a large mutual-fund group. Janus portfolio manager Thomas Marsico started buying Merrill two years ago and estimates the stock has earned his funds some $100 million. Another Merrill owner: the Fidelity Select Brokerage & Investment Management fund. It's up a neat 16.4% for 1993 through Apr. 16, vs. a 3% gain for the Standard & Poor's 500-stock index.

Much of the brokerage industry's recent fortunes have come courtesy of Federal Reserve Chairman Alan Greenspan. The bond rally in late 1992 benefited all brokerage businesses. Low rates jolted individuals into higher-yielding mutual funds and stocks and corporations into refinancing debt. Brokerage firms also earned interest income just by borrowing money at low short-term rates and collecting higher yields on long-term bond inventories.

Many analysts, though, think interest rates have fallen about as far as they can go and may even start creeping back up as the economy improves. "The next interest-rate shock is bound to be on the upside," says Moszkowski. That could mean that investors will feel less urgency to reconfigure their portfolios and corporations will have less incentive to refinance. Already, one measure of retail activity has peaked, with Schwab's client transactions tallying 34,100 a day in March, down from 40,000 in February. Street executives also doubt the lofty level of activity is sustainable. "We've got to be at a high part of a cycle," says one executive.

VOLATILE HISTORY. There are still believers out there. Janus' Marsico is holding his Merrill shares. Even in a weak market, he says, Merrill will earn stable fee-based income and can capitalize on opportunities overseas. "It should be a good stock over a 12-month time frame," he says. PaineWebber Group Inc. is a favorite of Scott Offen, Fidelity Select Brokerage's fund manager, because its return on equity is as high as Merrill's but it is selling far more cheaply.

The bulls also argue that long-term, individuals will increase their investments in equities, including mutual funds. The figure is now 18% of household assets, vs. 36% at the 1968 peak, says Fidelity's Offen. "People will be saving in longer-dated financial assets rather than cash or their homes."

It's still possible that interest rates will unexpectedly dive yet again. But if not, brokerage earnings will have a tough time going up from here.

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