Broker Stocks Outlast Skeptics

Odds are, if you'd bought a brokerage stock during the past three years, you made money -- maybe a lot of money.

In fact, since the bull market began in the autumn of 2002, few sectors have done better than brokerage stocks. This year alone, the brokers are up an average of 12%, far outpacing the broader market.

As a group, brokerage stocks are up 242% since bottoming in October 2002, as measured by the Amex Broker Dealer Index. Over that time, the S&P 500 is up 64%, while the Dow Jones Industrial Average has risen 48%.

It's no contest when comparing the performance of the brokers with their financial siblings, the banks. The 72% gain registered by the Philadelphia KBW Bank Index over the past three years looks paltry when stacked up against the triple-digit gains rung up by the brokers.

But the long party in brokerage stocks might be winding down, as fears of higher inflation and an eventual economic slowdown begin to mount in some corners of Wall Street. Others worry that big investment banks such as Goldman Sachs(GS Quote) and Bear Stearns(BSC Quote) are taking on too much risk in fueling trades by hedge funds, and that some of those bets eventually will come back to haunt Wall Street firms, especially if the economy softens.

"I don't think the juice goes out for a while. But the problem is these stocks are valued for consistent earnings growth,'' says Michael Stead, manager of River Aire Investment, a hedge fund that invests in financials and owns shares of Morgan Stanley(MS Quote) and Merrill Lynch(MER Quote). "If there is a hiccup, these stocks will sell off.''

Ironically, the good times are threatened even as three big brokers -- Goldman Sachs, Lehman Brothers(LEH Quote) and Bear Stearns -- are each expected to report double-digit improvements in their first-quarter earnings next week. Only Morgan Stanley, the other Wall Street firm whose first quarter ended Feb. 28, is expected to report a slight decline in quarterly profits.