Brokerage investors looking for a silver lining in the clouds that rained hurt on the U.S. market last week aren't going to find one.
It's that simple. In a market that had been driven by momentum, by potential, by the boundless hopes of new offerings, there simply wasn't much left after a week in which the tech stocks that carried the
to unprecedented heights came crashing down.
For brokers, the most vulnerable revenue drivers are investment banking, proprietary trading and commission revenue, all key factors that are likely to dry up in the wake of Friday's 617-point
washout and 355-point Nasdaq demolition, especially if the market keeps weakening.
"This is not good for anyone," says Michael Holland, a money manager who holds a broad portfolio of financial stocks. "The optimists and cheerleaders will say that we'll have more M&A now, but the pie is just smaller."
Morgan Stanley Dean Witter
and the rest of the big brokers were shredded by investors. Merrill fell 8.6% to 90; Goldman slid 13% to 82 3/4; Morgan dropped 11.4% to 66 7/8; and Lehman took an 18.5% hit to land at 75 5/8.
As online brokerages and developments in the electronic realm of Wall Street's business have eaten into commission margins, major investment banks have come to rely heavily on the busy initial public offering calendar to generate fat fee revenues.
Merrill's investment banking revenue hit $1.13 billion, about 19% of its net revenue for the fourth quarter. At Goldman, almost 28% of its $4.49 billion in net revenue came from the investment banking business. Morgan Stanley's numbers were in the same range.
A market that hates brokerage stocks with a passion naturally also has it in for banks like
, which have earned huge sums from capital markets over the past several quarters. (In general, banks are experiencing solid earnings growth, but there are some
concerns that they're chasing loans at the expense of credit quality.)
Chase and Citigroup were both off about 6.5% Friday. Some investors think that both banks, which were darlings of the market only a week ago, could be in the doghouse for at least a quarter as profits come in lower as investment banking business drops off.
A sea change in perceptions of both institutions is taking place, says Tom Brown, manager of New York-based
Second Curve Capital
, an investment firm that focuses on financial stocks. "The earnings outlook for Chase and Citigroup has clearly been affected by the market action this week," says Brown, whose fund has no position in either bank.
In the fourth quarter, Chase made an incredible 65% of its operating earnings from market-related businesses, including its private-equity arm
Chase Capital Partners
, the subject of a recent
, publisher of this Web site, has received financial backing from Chase Capital Partners.)
In 1999, Citi made around 30% of its core income from its brokerage
Salomon Smith Barney
and its so-called investment activities arm, a big rise on the 1998 share of 20%.
"SELL Brokerage Stocks and Money Center Banks" was the title of a timely research note sent out a week ago by New York-based
Charles Peabody. The outlook for second-quarter earnings at these firms isn't good, he says. "The IPO market's dead, venture capital gains are suspect and even trading volumes are going to be questioned," says Peabody.
"All rational people know that what we've had hasn't been sustainable," says one Chicago hedge fund manager who specializes in financial services plays. "We're going to revisit the volatility of earning in the sector. That's what makes these things cyclicals."
Stocks in brokerages and markets-exposed banks are also being hit "by worries about hedge funds blowing up," says Jonathan Iseson, manager of the Long Island-based
fund. The fear is that hedge funds highly exposed to tech stocks may not be able to pay back loans made to them by financial institutions.