Alex. Brown & Sons Inc.'s decision last week to sell to Bankers Trust New York Corp. stampeded investors into brokerage stocks. It was irrational exuberance on display, according to observers of the securities industry.
Wall Street analysts are not eager right now to tout brokerage stocks amid rising interest rates, a queasy stock market, and stagnation in equity underwriting, as the economy seems ready to downshift.
"There's concern that there will be a slowdown, and this group reacts quickly and sharply to that," said Joan S. Solotar, an analyst at Donaldson, Lufkin & Jenrette Securities Corp., New York, specializing in the brokerage and financial services industry.
Ms. Solotar has "buy" ratings on Lehman Brothers, Morgan Stanley & Co., and Dean Witter, Discover & Co. (the latter two are merging), and "hold" or 'neutral' ratings "on just about everybody else," she said.
The late-winter stock market slowdown means brokerages' fee income from debt and equity underwriting was probably 25% to 30% lower in the first quarter than the fourth, she said. Numerous companies have delayed initial public offerings.
"We may not have seen the last of the correction" for stocks, emphasized Raphael Soifer, an analyst at Brown Brothers, Harriman & Co., New York. "It would be normal now to retest the lows."
Given this outlook, Mr. Soifer right now rates only one stock a "short- term buy." That is U.S Trust Corp., which manges money for high-net-worth families and individuals. Longer-term he likes J.P. Morgan & Co., Morgan Stanley, and Merrill Lynch & Co.
The market's slippage and the falloff in stock underwriting means brokerages and investment banks with strong merger and acquisitions departments are the most likely to turn in strong quarterly earnings, Ms. Solotar said.
Publicly traded firms with strong M&A operations include Morgan Stanley, Merrill Lynch, J.P. Morgan, and Donaldson, Lufkin & Jenrette.
But Richard K. Strauss, a financial services industry analyst at Goldman, Sachs & Co., said that M&A activity will prove to have fallen 20% in the quarter, and that revenues are unlikely to beat 1996's robust figures.
The Alex. Brown-Bankers Trust deal especially caused regional brokerage stocks like those of Baltimore-based Legg Mason Inc., St. Louis' A.G. Edwards Inc., and Memphis' Morgan Keegan Inc. to rise sharply in anticipation that they might be bought next-at hefty premiums.
But observers of the brokerage industry caution that these are precisely the kinds of firms most vulnerable to a downturn in equity underwriting and retail stock sales.
Now is not the time to "buy into acquisition stories," Mr. Strauss warned. His lone "recommended list" stock is Wall Street warhorse Merrill Lynch; he figures Merrill's diversity of business lines make it proof against a downturn. Additionally, he rates both Donaldson, Lufkin & Jenrette and Salomon Brothers as market outperformers.
More fundamentally, and against much of the conventional wisdom right now, Ms. Solotar doesn't anticipate a wave of takeovers in the brokerage business-despite the Alex. Brown-Bankers Trust deal.
"Generally, I don't think there's a need for consolidation" in the securities industry, she said. "A company like Merrill Lynch certainly doesn't need to purchase a firm, although I know there is interest among commercial banks. The main question right now is whether these firms are at the top of their cycle."
Mr. Strauss said there is ample evidence that they are-but won't be much longer. He expects interest rates to rise further, bringing further "choppy conditions" to the sector. That ultimately could make securities firms more affordable for expansion-minded banks.
