SECTOR WATCH: A Big Week for the Brokers

Bear Stearns () has been among the financial institutions hardest hit since credit worries rattled Wall Street. The selling really gathered momentum in mid-July when the firm disclosed that two of its hedge funds had been wiped out due to exposure to securities that invested in subprime loans. Shares fell 13.4% during the month of July and are down nearly 40% from their best levels of the year. Bear Stearns is scheduled to report next Thursday, September 20, before the opening bell.

Lehman Brothers () is also well off its 2007 highs. Shares suffered a two-month 27.7% drop during July and August. Investors have been selling shares on concerns about the firm’s exposure to subprime mortgage securities, which could result in a possible hit to third quarter profits.  Lehman will kick off the third quarter earnings releases for the sector with a report on Tuesday morning, September 18.

Morgan Stanley () is scheduled to release earnings on Wednesday, September 19 before the opening bell. The stock is down nearly 25% since late June. Goldman Sachs () releases results the next day. Shares of the investment bank are down 15.5% so far in the third quarter. The other major bank, Merrill Lynch () doesn’t report until mid-October.

Nevertheless, next week’s earnings hold important implications for the investment banks. Historically, the major firms have been able to post quarter earnings that top analyst estimates by a wide margin. They are known to “beat the Street” estimates consistently and with a relative amount of predictability. (They are the masters of their own game.)

There is a lot less predictability this quarter, however, because of the industry’s exposure to turmoil in the credit markets. While the problems have been widely discussed in the financial press, the extent of the damage is still unknown. As of yet, there has been no way to quantify the real impact to earnings. Third quarter profit estimates for Bear Stearns have already been cut in half since the start of the quarter. Lehman and Morgan Stanley forecasts have also been revised lower. However, are analysts still too optimistic and have estimates been lowered enough? Or, maybe there is too much pessimism and estimates have been lowered too much?

Figure 1: AMEX Broker/Dealer Index Monthly Chart

Meanwhile the uncertainty and unpredictability for third quarter earnings comes at a time when the AMEX Broker/Dealer Index seems to be facing an important test. Figure 1 shows the long-term price action of the index, which tracks the performance of a dozen different investment firms. The sector has been in a five-year bull market, but that bullish trend was tested in July when the index suffered its third consecutive monthly decline. The XBD has since been able to stabilize and hold steady since that time. However, next week’s earnings could lead to another round of volatility in the brokerage stocks and, if the numbers disappoint, the XBD could return to revisit its August lows. A move beyond that would signal that the troubles in the brokerage sector are far from over.  

Frederic Ruffy
Senior Writer & Index Strategist
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