Merrill Lynch ( MER) investors need something to get excited about. In the first three weeks of 2005, Merrill's stock has given back all of its 3% gain from last year and then some. The stock closed Friday just under $57. Worse, Merrill's shares lagged well behind most of its competitors in 2004 and the Amex Securities Broker/Dealer Index, which rose 15%. The only big brokerage stock to fare worse than Merrill was Morgan Stanley ( MWD), which ended the year essentially unchanged. But Merrill fans might get their shot in the arm Tuesday when the brokerage reports fourth-quarter earnings. That is if they can look beyond the messy headline number and focus on the brokerage's prospects for 2005 -- assuming the economy doesn't falter. On the surface, Merrill's earnings will be nothing to cheer about. The Thomson Financial consensus estimate has profits per share down about 10% to $1.10, compared with $1.23 in the year-ago quarter. But Wall Street is expecting a rebound at Merrill in 2005, as economic trends play to the brokerage's advantage. The full-year consensus has earnings rising 11% to $4.79 a share. By contrast, Wall Street analysts expect full-year earnings in 2005 to decline slightly at Bear Stearns ( BSC), Goldman Sachs ( GS) and Lehman Brothers ( LEH), compared with last year. Like Merrill, Morgan Stanley also is expected to buck the downward trend. The catalyst for a reversal of fortune may be that more money is seen going into stocks than bonds this year, with interest rates expected to rise further. Rising interest rates means bond trading and debt underwriting, two big profit centers for much of Wall Street last year, will not be as lucrative in 2005. That's bad news for bond powerhouses like Bear Stearns and Lehman. But for Merrill, which has never been a premier player in the bond market, any slowdown in the debt markets is seen as a manageable event.
The good news for Merrill is that stocks are its bread and butter. Anything that helps the equities market is good for the firm's bottom line. Most obviously, an uptick in stock trading means more commission dollars for Merrill, which generates about 36% of its revenue from retail customers. A revival in equities also should lead to additional stock underwriting opportunities and corporate deal-making, two areas of investment-banking work in which Merrill has moved to re-establish itself as a leader. "Merrill is not famous for being a fixed-income trader. But they do have the largest retail operation in North America,'' says Brad Hintz, a brokerage analyst with Bernstein & Co. "Institutional equities are looking better. IPOs are looking better. In this quarter they will show a lot of traction in investment banking.'' Of course, the stock market hasn't been cooperating yet with the bullish scenario. Last year's big postelection rally led to lots of selling early in January. The bulls on Wall Street are optimistic that buyers will return to the market once fourth-quarter earnings are out of the way. But some on Wall Street are beginning to fret that the November and December rally was nothing more than an apparition. After the selling is finished, stocks may once again zig and zag as they did for much of last year. A dull stock market would be particularly bad news for Merrill. In the third quarter of 2004, Merrill's earnings slid 8% and revenue fell 3.2%, mainly because many of its customers sat on their hands. Aside from a robust stock market, another thing that could provide added juice to Merrill's earnings going forward is the firm's re-entry into the energy trading business. Last year, Merrill acquired Entergy-Koch's trading business for a little over $800 million in a bid to catch up to Goldman Sachs and Morgan Stanley, Wall Street's two biggest players in the energy market. One analyst estimates Entergy-Koch's trading business was earning between $100 million and $150 million a year. But ultimately, Merrill's fortunes in 2005 will come down to a healthy economy and rising stock market.