The Market Blahs Are Hitting Wall Street's Bottom Lines

As profits fall, smaller online firms could get swallowed up

The news from Goldman Sachs on May 25 was a blow. Nearly all of the company's major revenue streams had slowed steadily since mid-March, according to analysts who then slashed second-quarter profit estimates by as much as 10%. Most troubling: Billions of dollars in investments in recent Internet initial public offerings have declined sharply in value. Goldman's stock plummeted 9% that day, to $73 a share; in total, it has lost nearly half of the $60 billion market value it boasted in March.

Goldman, Sachs & Co. isn't the only financial-services company with problems--or with high-tech investments that are unlikely to pay off anytime soon. Thanks to the Nasdaq slide that began in mid-March, many industry leaders may face profit declines simply from the dramatic dip in trading. Volumes are down by a third since the peak in March. Add to that the slowdown in mergers and acquisitions and the near-collapse in initial public offerings, and the picture gets pretty bleak, even if the market decline goes no further.

The only question now is how hard and how far the fortunes of financial-services companies will fall--and when that will begin to translate into layoffs in an industry that, like the tech world, has seen substantial growth in payrolls. Already, Brown Brothers Harriman & Co. has backed away from going head-to-head with the bigger brokerages in equity research; on May 31, it laid off 78 people in its equity-brokerage unit. "The industry has been going at an unsustainable pace," says Morgan Stanley Dean Witter analyst Henry McVey.

Still, none of the big brokers or banks seems to face imminent risk of losses, as they did during the two previous market downturns in 1998 and 1994. And one major investment bank that asked not to be named claims that "only a protracted bear market" would even "slow our hiring." With such a tight labor market, this banker says, it would be foolish to lose good employees because of a short-term market dip.

Nonetheless, even without more of a market downturn, companies with fortunes that are most directly tied to declining trading volumes and the flagging fortunes of high-tech stocks are likely to feel some pain. Morgan Stanley, Merrill Lynch, Chase Manhattan, and Citicorp could all take profit hits in coming quarters.

GOUGED PORTFOLIOS. Chase, in particular, may be in for trouble soon. At the end of the first quarter, the New York-based company had a $4.4 billion portfolio of tech stocks that added 14% to its quarterly earnings. But some of those holdings, including Triton PCS Holdings Inc. and TeleCorp PCS Inc., have dropped 40% in value, says Keefe, Bruyette & Woods Inc. analyst David S. Berry. If those stocks don't recover by the end of June, Berry estimates that market declines could shave 20 cents, or almost 25%, off his current second-quarter per-share earnings estimate of $1.25. A Chase spokesman declined to comment on estimates but said that fluctuations in the company's venture-capital portfolio are not affecting hiring or spending.

The risks are also high for online brokerages, many of which could end up disappearing in a wave of consolidation. Shares of Muriel Siebert & Co. and Ameritrade have been hit hard, making those companies potential acquisition candidates, analysts say. Muriel Siebert, who heads her namesake firm, claims it is not for sale. But she agrees that acquisition deals are coming: "I'd expect a consolidation to start, and when it starts, it'll be fast." She predicts that as many as 20% of the nation's 150 brokerage houses could disappear or be acquired.

Even the largest online brokers are seeing big cuts in trading-commission revenue. But Ameritrade President Jack R. McDonnell says he is continuing to hire, adding: "We're hunkering down and getting ready for when the market turns" north.

Mutual funds had also been hiring at a torrid pace over the past year. In May, however, they saw a sharp drop in cash flowing into the industry, according to Bob Adler, president of AMG Data Services. Since that was the first sign of industry problems, no imminent moves are expected. Deposit flows into mutual funds were unusually strong right up through April, Adler says. Nonetheless, few observers doubt that a prolonged market downturn could accelerate industry consolidation and force some of the hundreds of new mutual funds that have launched in recent years to close.

So the champagne is not quite flowing on Wall Street these days. After 11 weeks of the most severe market downturn in years, the industry is bracing for trouble--and crossing its fingers that Federal Reserve Chairman Alan Greenspan can pull off the soft landing he is promising without bruising the market further.

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