For Merrill Lynch, Doldrums Came Early

Updated from 11:18 a.m. EDT

The listless trading that characterized the second quarter and helped contribute to weaker-than-expected earnings at Merrill Lynch ( MER) is likely to remain in place throughout the third quarter, some analysts say, as retail and institutional traders sit out the summer months.

Low levels of volume and volatility sent Merrill's trading revenue down 40% sequentially in the second quarter, with revenue from both global equity and global debt markets falling sharply. As a result, Merrill reported earnings that missed analysts' estimates.

Unfortunately for Merrill and other Wall Street brokers, some experts say things aren't likely to get much better over the next three months.

"The summer is typically a less-volatile time, there's less trading volume so one would expect the trends that we saw in June to at least continue, if not even get a little worse as we go into July and August," said Ken Worthington, an analyst at CIBC World Markets.

Worthington said volatility in fixed-income markets has ticked up "a little bit" this month but is still well below levels seen in April and May. Equity volatility has also risen slightly in July from the end of June but remains far below the levels seen in most of the second quarter. "My guess is people will start to model-in down earnings for the September quarter," he said.

Analysts surveyed by First Call are expecting Merrill to earn $1.09 in the third quarter. In the three months ended June 30, the company earned $1.08 billion, or $1.06 a share, compared with earnings of $977 million, or $1 a share, in the same period last year.

Revenue rose less than 1% from a year ago to $5.30 billion. Analysts polled by Thomson First Call were forecasting earnings of $1.09 a share on revenue of $5.71 billion.

Although Merrill's results were disappointing, they weren't surprising given recent updates from online brokers Ameritrade ( AMTD), E*Trade ( ET) and Schwab ( SCH). All three reported weaker trading volumes in May, as many retail investors stayed away from the markets on concerns about high oil prices, geopolitical events and the possibility of rising interest rates. Ameritrade and Schwab have both tempered their earnings guidance for the second quarter.

"The typically slower summer period started early as was clearly evidenced by the lower levels of client activity, especially at the end of the period," said Merrill's Chief Financial Officer Ahmass Fakahany on a conference call Tuesday.

Revenue from equity trading fell 23% sequentially in the second quarter, while revenue from fixed income trading declined by 22%, "as many institutional investors chose to remain on the sidelines amid uncertain markets," according to Merrill.

Investment banking revenue decreased 9% sequentially and underwriting revenue fell 7% from the prior quarter. On a year-over-year basis, however, investment banking rose 9.5% to $760 million. "Nevertheless, with the summer slumber now kicking in, the follow-through will no doubt be muted, at least short term," said Deutsche Bank analyst Richard Strauss.

Commission revenue fell 13% sequentially, reflecting the weak equity markets volume. Commissions on individual securities fell by one-fourth, while those on mutual fund transactions were down 5%.

"There is a general lack of feeling one way or the other," said James Altucher, a managing partner at First Angel Capital and contributor to TheStreet.com's sister site RealMoney.

"I don't think the Merrill news is any kind of blanket statement on the market or the economy, but just a reflection of what we've all noticed: The markets lack interest more than they lack value."

Shares of Merrill fell 2.8%, or $1.43, to $50.04. Still, Lehman Brothers analyst Mark Constant said he believes Merrill's stock price has become "quite depressed" in recent weeks amid speculation of a weak second-quarter performance.

"In fact, we would argue that the current valuation (at just 1.65 times book value, or below the level were the stock traded in the aftermath of the Long-Term Capital Management crisis in 1998) has become downright compelling," he wrote in a research note. "For fundamental and/or contrarian investors who are willing to look beyond a somewhat challenging near-term earnings environment and appreciate a company that has dramatically enhanced its profitability across cycles.

Other analysts said they were pleased that Merrill has been buying back stock and has agreed to buy back another $2 billion worth of shares.

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