Broker Stocks Feel the Pain

The laws of gravity do apply to brokerage stocks.

Over the past month, as the market has taken a fierce beating, the air has rushed out of the minibubble that had developed in brokerage shares. Since setting an all-time high in mid-April, the Amex Broker-Dealer Index has fallen 14%.

Some of the brokerage stocks hit hardest this past month include Ameritrade (AMTD Quote), Goldman Sachs (GS Quote), Lehman Brothers (LEH Quote) and Merrill Lynch (MER Quote).

Before investors pulled the plug on the brokerage sector, the Broker Dealer Index was up 23% for the year. In the wake of the selloff, though, the index is now up just 6%.

If the selling in brokerage stocks has outpaced the decline in the broader market, brokerage stocks had been one of the market's top performing sectors -- so a stronger selloff is not all that surprising.

Analysts who follow the brokerage sector aren't surprised. They say the rally had gotten ahead of itself and stock prices had gotten too frothy.

"The brokerage stocks were looking a bit overvalued, so I believe this is an overdue correction," says David Trone, a Fox-Pitt Kelton analyst.

Historically, brokerage stocks are particularly volatile. When the broader market is performing well, brokerage stocks tend to outperform. Likewise, when stocks slump, shares of brokerages tend to get hit harder.

The current wave of selling on Wall Street is being precipitated by concern about a resurgence in inflation. Traders and investors fear the Federal Reserve will now be less likely to hold the rein on further interest rate hikes, something that's never good for stocks. Earlier this year, stocks rallied strongly on the belief that Fed was ready to put the kibosh on further interest rate increases.

What's not clear is whether investors will return to the brokerage sector once the broader market stabilizes, or if the fast money crowd will look elsewhere now for fat returns.