Before investors add or build any positions in the investment banking industry, research firm Sandler O'Neill & Partners said they should wait for a fundamental recovery.

"Investors should wait for a pullback in sector valuations or upward earnings revisions," said analyst Jeffery Harte. He downgraded both Bear Stearns ( BSC) and Goldman Sachs ( GS) on Thursday to hold from buy, saying their prices have gotten too high.

Harte said current valuations reflect that a late 2003 cyclical recovery is possible in capital markets, "however, we believe consensus earnings estimates continue to underestimate the magnitude of recovery."

Share prices for both Bear Stearns and Goldman Sachs are within 10% of Sandler O'Neill's price targets. Bear Stearns' $81 target represents a valuation of 1.85 times the brokerage's first-quarter 2004 book value estimate of $43.74 a share, Harte said.

Meanwhile, Goldman Sachs' target of $91 is an absolute price-to-book valuation of 2.13 times Sandler O'Neill's first-quarter 2004 book value estimate of $42.65 a share.

Shares of Bear Stearns rose 59 cents to $80, and Goldman gained $2.05 to $87.30.