By a wide margin, brokerage stocks have outshined the broader market in 2004. But duplicating that feat next year might prove prohibitively difficult.
Going into the final weeks of the year, the
Amex Securities Broker Dealer Index
is up 12%, twice the gain over the same period in the
. The broker index is also wiping out the
, which are essentially flat for the year.
Almost all the gains in the broker index, along with the broader market, have come in the past two months.
Leading the charge is
( BSC), up 30% to $102 a share -- an all-time high. Other big gainers include
( LEH), up 18%, 17% and 11%, respectively.
Some of the outsize gains in the brokerage sector have been fueled by predictions of another wave of industry consolidation. That's been especially true in the case of Bear Stearns, which many say could be attractive to a European bank, given its dominance in the bond business and large hedge-fund clientele.
But the rally in brokerage stocks also reflects Wall Street's ability to churn out decent profits, even in a generally mediocre year for the overall market. Notwithstanding a third-quarter earnings hiccup due to a slowdown in retail stock trading, most Wall Street firms are expected to post higher full-year 2004 profits compared with the prior year.
And it's worth remembering that 2003 was a banner year for Wall Street with the industry posting $24 billion in pretax income, according to the Securities Industry Association. The industry's profits in 2003 were up 100% from 2002, which marked the depth of the recession and job cuts on Wall Street.
One way Wall Street has managed to keep generating higher profits is by moving slowly on hiring. With total employment in the securities industry down 6% from the prerecession peak in March 21, Wall Street is doing more with less.
The biggest firms also are relying more than ever on bond, stock and commodity trading to juice earnings. With all the volatility in the oil market the past several months and the post-Labor Day revival in equity trading, the expectation is that trading revenue will account for a good chunk of the fourth-quarter profits at a number of Wall Street firms.
But with four big Wall Street firms, Bear Stearns, Lehman,
( MWD), set to report fourth-quarter earnings over the next two weeks, there are indications that 2005 may not be as kind to brokerage stocks.
For starters, the earnings picture for the fourth quarter of 2004 is likely to be a mixed bag. Most analysts, as surveyed by Thomson Financial, expect earnings to decline at Bear Stearns, come in flat at Lehman Brothers and rise at both Morgan Stanley and Goldman Sachs. Merrill Lynch, which ends its fiscal year on Dec. 31, is expected to report a modest decline in fourth-quarter earnings.
The Thomson Financial consensus estimate has Bear earning $2.13 a share, compared to $2.19; Goldman Sachs earning $2.30, compared to $1.80; Lehman earning $1.70 compared to $1.71 and Morgan Stanley earning $1.02 compared to 94 cents.
The profit outlook for 2005 is equally muddled.
Overall, Wall Street analysts expect full-year earnings in 2005 to decline slightly at Bear Stearns, Goldman Sachs and Lehman, compared to this year, according to Thomson Financial. The only two big firms expected to buck that downtrend are Morgan Stanley and Merrill Lynch, which have been two principle laggards in the brokerage sector this year.
The uneven profit picture at Wall Street firms mirrors the expectations that the nation's economy will grow at a slower pace next year. Frank Fernandez, the Securities Industry Association's senior economist, foresees only "modest gains'' in stocks next year. He also sees bonds taking a hit from rising interest rates, something that's not good for bond traders.
Retail investors, meanwhile, may have less money to invest in the market next year, as rising interest rates suck the life out of the mortgage refinancing the market. Over the past two years, homeowners, mainly through so-called cash-out refinancings, have extracted a little more than a half-trillion dollars in cash from their homes, according to the Federal Deposit Insurance Corp. Some of that cash no doubt has made its way into the stock market, as well as the overall economy.
A traditional line of investment banking work, advising on corporate deals, is also showing signs of lethargy after a strong first half in 2004. Across the securities industry, revenue from deal advisory work is expected to be down about 27% in the fourth quarter from a year ago, according to David Trone, a brokerage analyst with Fox-Pitt Kelton. Meanwhile, an investment-banking source says he sees no signs of a year-end rush of corporate mergers.
Wall Street should enter 2005 with about 120 pending initial public offerings in the pipelines, a sharp increase over previous years, according to Thomson Financial. But many of those stock offerings have been in the works for many months. To date, there have been only four new stock deals registered in December.
Of course, much of Wall Street's fate is tied to how the economy performs. If the economy grows at a faster clip than most expect, brokerage stocks could once again be off to the races in 2005.