Tough Summer for Brokerages

Summer is a hard time to be a stockbroker. This year, it could also be a hard time to be a brokerage investor.

In the midst of what is historically the slowest quarter on Wall Street, the Amex Securities Broker-Dealer index, which tracks the performance of large broker-dealers and online brokers such as E*Trade(ET) and Ameritrade(AMTD), has dropped 13% in five weeks. The decline virtually wiped out what had been a significant gain in the year to date.

Alarmingly, last week's leg of the downturn occurred as three of the industry's biggest players reported very strong earnings for their May quarter. Lehman Brothers(LEH), Goldman Sachs(GS) and Bear Stearns(BSC) all blew away Wall Street forecasts -- and each saw their shares end the week about 3% below where they began.

"The core question is if anyone really cares about the earnings of these companies, and the fact is that no one does," says Richard Bove, equity analyst at Punk Ziegel.

That looked especially true in light of last week's stock market reaction. "International fixed income is good, commodities are strong, and there is a cornucopia of deals in the pipeline for investment banking revenues," noted Brad Hintz, equity analyst at Sanford Bernstein. "Goldman shows prime brokerage up 34%, so hedge funds are active."

So why the selloff? For one thing, investors were spooked by somber modulations in Goldman's and Lehman Brothers' post-earnings conference calls. Goldman CFO David Viniar told investors that while May's selloff wasn't a factor for the bank's earnings, "If market weakness continues for another four or eight weeks, that could change." At Lehman, meanwhile, CFO Chris O'Meara spoke of asset markets that forced both "a recalibration" among clients and a "reallocation of assets."

In last week's panicked trading, the comments were enough to confirm the worst fears of many investors: That more Federal Reserve rate hikes are likely to beat down equity and commodities markets, and that brokerage earnings and their share prices face ruin as the economy rolls helplessly into a recession.

To view Lauren Silva's video take on this article, click here.