SAN FRANCISCO --Rumored merger talks between Yahoo! (YHOO) and Excite@Home (ATHM) - Get Report created an early stir before negative sentiment once again grabbed the Net sector by the throat, driving stocks lower.

TheStreet.com Internet Sector

index was down 15.09, or 2.8%, at 524.94 after trading as high as 553.42 early on. Yahoo! and

America Online

(AOL)

led early decliners as traders considered the ramifications of a possible deal, and online brokers were taking a hit on the heels of an analyst report suggesting trading volume won't continue its breakneck growth pace in the second half.

Business Week Online

reported that Yahoo! has held talks to purchase Excite@Home for an amount greater than Excite@Home's current value of $17 billion. The article speculated that Yahoo! probably doesn't want to operate an infrastructure company like @Home and would likely spin out @Home into an independent company in which Yahoo! and

AT&T

(T) - Get Report

-- which already holds a controlling interest in Excite@Home -- owned sizable stakes.

Merrill Lynch

analyst Henry Blodget said Yahoo! could eventually partner with

Microsoft

(MSFT) - Get Report

and AT&T to "mount a competitive challenge" to AOL. Blodget noted that Yahoo! and Microsoft are already collaborating on instant messaging software, and he has "long believed it possible that Microsoft might eventually buy Yahoo!"

"If these three players were to coordinate and decide to create a new online service (Yahoo Online?) we believe it could be an effective competitor to AOL -- at least much more so than any existing online service competitor," he wrote.

In early trading, Excite@Home was up 3 1/8, or 7%, at 46. Yahoo! was down 6 1/8, or 4%, at 126 3/16. AT&T was up 3/8, or 1%, at 51 7/8. Also, Microsoft was up 5/16 at 85 1/8, and AOL was down 3 1/4, or 3.6%, at 89 5/8.

The other big story was a dour report on the online brokerage group by influential analyst Bill Burnham at

Credit Suisse First Boston

. In a note today, Burnham wrote that online trading volumes rose only slightly in July vs. June and could actually show a sequential decline in the third quarter from second-quarter levels.

Burnhman said weakness in Internet stocks during July "appears largely to blame" for the trading drop-off. He noted that July share volumes in stocks he tracks fell 54% from April levels, and there was "a chance that online trading even lost share to the general market, which grew 5.6% over June."

"This is clearly a short-term negative for the group. We don't expect a recovery until late September or mid-October," he wrote.

In early trading,

Ameritrade

(AMTD) - Get Report

was down 1 3/8, or 6%, at 22 5/8 and

E*Trade

(EGRP)

was down 3 1/8, or 11%, at 25 7/8.

Internet IPOs will be in the spotlight later this morning with the debut of

1-800-Flowers.com

(FLWS:Nasdaq), which was priced above-range at $21 on Monday by

Goldman Sachs

. The deal was expected at $16 to $18. Also,

Hambrecht & Quist

Monday priced 5 million shares of

Quotesmith.com

(QUOT:Nasdaq), an Internet-based insurance service, top-range at $11 a share.