Shifting winds of war blew financial stocks lower Monday.

Banks, insurance and brokerage stocks -- along with the broader market -- sank Monday as last week's optimism was replaced by gloom over the death and capture of American soldiers in Iraq. At midday, the Philadelphia KBW Bank Index was down 3%, while the Amex Broker Dealer Index tumbled nearly 4%.

On Friday, strong gains in financial stocks helped pushed the broader market higher, as investors on Wall Street placed bets on a quick end to the war in Iraq. Both the bank and broker indices rose 2% on Friday.

Monday's losses were widespread, with banks, brokers and insurers all taking big hits.

Citigroup

(C) - Get Report

lost $1.37, or 3.7%, to fall back to $35.83. Shares of

Goldman Sachs

(GS) - Get Report

dropped $2.30, or 3%, to $69.79.

American International Group

(AIG) - Get Report

fell $2.30, or 4%, to $52.25. One of the biggest losers on the day was the credit-card giant

American Express

(AXP) - Get Report

, which plunged $1.70, or 4.5%, to $36.17.

For now it seems financial stocks -- whatever their fundamentals -- will be tied directly to the progress of war.

For investors who can look beyond the geopolitical turmoil, however, there are tentative signs of a recovery in the financial sector, after months of job cuts, investment losses, bad loan write-offs and regulatory investigations. Better-than-expected first-quarter earnings reported last week by four big Wall Street investment banks give financial investors reason to hope that all is not lost -- despite one of the worst bear markets in decades.

The results from Goldman,

Bear Stearns

(BSC)

,

Lehman Brothers

(LEH)

and

Morgan Stanley

(MWD)

show it's possible for Wall Street firms to prosper, even in a down stock market, as long as there is a lot of volatility for traders to profit from. All four firms generated huge piles of cash from trades placed by customers on the red-hot bond and commodities market, as well as trades made by the investment firms for their own benefit.

Wall Street analysts were surprised somewhat by the big trading gains, and it's a reason the four investment firms handily beat the first-quarter earnings estimates. It's also the reason some analysts are now upping earnings estimates for several big banks with sizable bond and commodities trading desks, such as Citigroup and

J.P. Morgan Chase

(JPM) - Get Report

.

On Monday, for instance, Morgan Stanley bank analyst Henry McVey raised his full-year earnings estimate for Citigroup to $3.20 from $3.14 share. Last week Michael Mayo, Prudential Securities' influential bank analyst, cited the "strong fixed income and trading results reported by the brokerage firms" as the reason behind his decision to raise Citigroup's first-quarter earnings estimate by a nickel to 78 cents a share.

Mayo offered a similar rationale for raising the first-quarter estimates on J.P. Morgan.

But there also are dangers in reading too much into these rising estimates. Trading revenue can be fickle, especially when much of the gains come from proprietary trading, or market bets made by a firm's own traders. If a firm makes too many bad bets, its earnings could suffer.

That's the reason Fox-Pitt Kelton financial services analyst Reilly Tierney said he senses that some investors remain wary of Morgan Stanley, which posted the biggest earnings surprise of the four investment firms last week. Tierney said investors weren't expecting much from Morgan Stanley when it came to proprietary trading, and they question whether it can duplicate those results.

But Tierney said investors shouldn't focus so much on whether Morgan Stanley can replicate its first-quarter trading numbers. He said it's a given that the firm won't. But Tierney said the trading performance is an indication that Morgan Stanley executives recognize there is a place for proprietary trading in a firm's revenue mix and they should be applauded for "getting it right."