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) - Get Report

and

Ameritrade

(AMTD) - Get Report

, 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

( BSC) 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

.

"Broker stocks are sensitive to interest rate trends and expectations about volumes in the market. Everything is softer," says Philip Roth, chief technical market analyst at Miller Tabak. "This is the biggest correction since the bottom of 2002, and it has a number of months to run."

Roth says that there may be "several mediocre recoveries" amid a broader decline in the coming months, which probably means the broker stocks will sell off as well. In fact, many portfolio managers are starting to readjust their portfolios and dump high-beta stocks, those that move closely with the equity market, and invest in defensive areas.

Even some people who are bullish on the brokers concede that sentiment has shifted.

"They'd rather hold

Kellogg's

(K) - Get Report

corn flakes than Lehman or Goldman," says Bernstein's Hintz. "Brokers were going down, frankly because

investors said they wanted to be defensive."

Other signs of a slowing equity market hit the headlines last week. When the equity market is going to fall, retail-investor trading slows. E*Trade Financial said last Wednesday that its customers made fewer trades in May, the month the markets began to tumble. It says daily average revenue trades fell by 3% in May from the April tally. E*Trade also said customer assets fell 5% in May to $184 billion.

The brightest spot in the brokerage space last week was

Bear Stearns

( BSC), whose upbeat outlook helped stanch the sector's bleeding on Thursday and contributed to the broader market's furious rally. On Friday, Sandler O'Neill analyst Jeff Harte upgraded the stock to a buy from hold and raised the price target by $6 to $151 per share.

"We remain bullish in our outlook for the capital markets environment heading into 2007 and note that the credit market continues to suggest that the economic- and business-sector environments are much stronger than reflected by the equity markets in recent weeks," the report said.

All that might be true, and certainly, when evaluating the brokers alone, the companies are positioned well. The large institutions continue to diversify their businesses by expanding overseas operations. Theoretically, this will give brokers strong earnings in the face of a U.S. equity decline.

"Domestic mergers only account for one-third of global M&A, and equity underwriting only about 35%," according to Hintz. "Certainly,

the brokers are diverse."

Still, it probably won't matter. The temperamental equity markets were volatile last week, despite a mostly positive message from economic indicators and broker earnings alike. That sensitivity is ultimately bad news for brokerage shares.