Rally Business Is Good

E*Trade's surprise optimism lifts the online brokerage sector.
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Should

E*Trade's

(ET) - Get Report

ability to convince investors it's turned the corner mean the same is true for stocks in general?

The online broker inspired a sectorwide rally Friday when it upped 2002 earnings forecasts and announced it was buying back 20 million of its shares. The announcement even eclipsed some bearish news from rival online brokerages and actually lifted shares of

Instinet

(INET)

, which simultaneously released a grim report on its own November volume.

Menlo Park, Calif.-based E*Trade said it expects to earn 40 cents to 50 cents a share next year, above the 34 cents analysts were predicting. E*Trade will also buy back 20 million shares from Softbank at $7.28 each. The stock, which has a 52-week range of $4.07 and $15.38, lately soared 8% to $10.59.

Cry to Me

The E*Trade news trumped disappointments disclosed separately by two of the sector's biggest players: Instinet and discount broker

Charles Schwab

(SCH)

. Schwab announced that it is exiting the Japanese and Australian markets because of weak trading conditions, and that it will take a fourth-quarter pretax charge of $35 million to pay for the international restructuring. Instinet, which went public in May, said Friday that its share volume fell 14% in November.

Their stocks lately rose; Schwab was up about 1% to $15.99, while Instinet gained 3.5% to $8.28. Rival

Ameritrade

(AMTD) - Get Report

rose in sympathy, gaining 3% to $6.70.

E*Trade and its peers have suffered from a sharp decline in retail trading activity. With an economic recovery far from certain, and the retail investor still skittish, experts were worried that 2002 could be a repeat performance of 2001.

On Nov. 15, UBS Warburg analyst Diane Glossman downgraded several traditional and online brokerage stocks, including E*Trade and Schwab, to hold from buy, citing concerns about their fundamental weakness.

She noted that improving trends in retail trading volumes were merely seasonal and not indicative of a "broader return of the retail investor to the equity markets."

Waiting in Vain

Glossman also cautioned that while brokerage stocks tend to lead an economic recovery by a quarter, there is still a lack of evidence of an upturn anytime soon.

Michail Shadkin, a professional trader at TraderPulse.com, thinks Wall Street has been too optimistic. "We're going to get through January, and then this market is going to realize that the growth that everybody thinks is happening is not going to happen," he said, estimating that the Nasdaq could fall to 1500 by February.

"For that reason I just don't see the uptick in online trading lasting more than a couple of months," Shadkin said. "I wouldn't touch the sector with a 10-foot pole."

Many of the beaten-down shares have staged a notable climb back over the past two months. E*Trade stock has rallied 103% since Sept. 11.

Is This Love?

There are fundamental reasons to like the stock, said Todd Halky, analyst at Putnam Lovell Securities, who has a buy rating on the stock. "We believe E*Trade is definitely positioned to perform in various environments, and we've seen the worst environment," Halky said.

The company's ongoing diversification initiatives, which include moving into the mortgage origination and banking businesses, are encouraging, said Halky. E*Trade saw its brokerage transaction revenue drop 30% last quarter, but net revenues only fell by 5%, Halky said.

"They've done an excellent job of hedging and diversifying themselves," he added.

Halky was more cautious about rivals Ameritrade and Schwab, which he has hold ratings on, citing the homogeneity of their revenue stream.

For optimists believing that it's a bull market time again, the stocks are good bets. "If the market continues to say it's the beginning of another bull run, then these guys are going to benefit more so than most other players," Halky said.