Morgan Stanley, owner of the world's biggest brokerage, is struggling to prove its new model works after failing to ride a surge in equity and bond markets.

The firm's post-crisis strategy of relying more on its 18,000 brokers and less on debt-fueled risk-taking has yet to lure investors to the stock, which slid 8% last year, underperforming rivals. As the Standard & Poor's 500 Index rose 13% and corporate bonds returned almost 11% in 2010, analysts cut estimates for the bank's full-year earnings.

Chief Executive Officer James Gorman, shortly after he took over the top job last January, said 2009 was a "year of transition" for the firm and that 2010 would be the "year of execution for Morgan Stanley." By October, that outlook had changed, as Gorman, 52, said Morgan Stanley was still in a "transition period" and "remains a work in progress."

"When a CEO says that, it means he knows he still has some near-term challenges and that he's very conscious of not trying to encourage unrealistic expectations," said Chris Kotowski, an analyst at Oppenheimer & Co. in New York. "To me, that's better than saying reassuring things and then not delivering."

Morgan Stanley, which reports fourth-quarter results next week, lagged behind Goldman Sachs Group Inc. and JPMorgan Chase & Co. in fixed-income trading in the first nine months, the second year it has done so. The New York-based firm, the sixth-largest U.S. bank by assets with more than 62,000 employees, backed off its profit-margin goals for the brokerage in July, blaming the May 6 market crash that briefly wiped out $862 billion in equity market value for scaring away retail investors.

Morgan Stanley may post profit of 34 cents a share for the quarter, according to the average of 21 analysts' estimates in a Bloomberg survey. The average estimate fell 15 cents in the past four weeks as 15 analysts cut their projections, many citing a weaker trading environment. The firm has posted $3.59 billion of net income in the first nine months of 2010, and analysts now say it may close the year with $4.47 billion, 14% short of what they forecast last January. That would still be more than triple the company's 2009 profit of $1.35 billion.

Mark Lake, a spokesman for Morgan Stanley, declined to comment about fourth-quarter results.

"It's taking a little bit longer than management expected," said Steve Stelmach, an analyst at FBR Capital Markets in Arlington, Virginia. "A lot of it is out of their control. If retail investors don't reengage, it's going to be tough for Morgan Stanley to do the hard work needed. If we can get a sustained recovery, that solves a lot of Morgan Stanley's problems."

Gorman said last month in an internal memo to employees obtained by Bloomberg News that the firm is poised for "accelerating" progress in 2011 after facing "difficult markets" in 2010.

"I could not be more optimistic about our prospects in 2011," wrote Gorman, who declined to comment for this story. "I believe that our stock is meaningfully undervalued, and that there will be a huge inflection point as we demonstrate to investors that our client-focused strategy is working."

Morgan Stanley's stock fell 8.1% in 2010, ending the year down 63% from its 2007 high.

"You can't take a lot of positives out of only being down 8%," said Douglas Ciocca, managing director at Renaissance Financial Corp. in Leawood, Kansas, which manages $2 billion in assets including Morgan Stanley shares. "There may be some steak at Morgan Stanley, but there's not much sizzle."

The slide came even as Morgan Stanley avoided many of the issues that plagued rivals in 2010. Goldman Sachs paid $550 million to settle a fraud lawsuit filed against the firm by the U.S. Securities and Exchange Commission. Bank of America Corp. and JPMorgan Chase have faced scrutiny from politicians and regulators over alleged improper foreclosures.

Rather, the biggest obstacle was the firm's performance. While the bank made progress integrating its retail brokerage joint venture and returning its asset-management business to profitability, it didn't achieve the turnaround in fixed-income trading that many analysts and investors were looking for.

The firm's overall trading market share among 10 of the largest global firms was 7.7% in the 12 months ended Sept. 30, up slightly from 7.5% in 2009 and down from 9.8% in 2006, according to data compiled by Kotowski.

Fixed-income trading revenue for the first nine months of last year was 30% less than any of the bank's largest U.S. competitors. After posting equity trading revenue in the second quarter that topped all of its largest U.S. competitors, Morgan Stanley slipped to fifth place in the third quarter.

Goldman Sachs, which gets 69% of its revenue from trading compared with 39% for Morgan Stanley, has had a quicker recovery from the financial crisis. After posting a Wall Street-record $13.4 billion profit last year, the New York-based firm may almost double Morgan Stanley's earnings in 2010.

"In 2009, you didn't want diversity, you wanted the business that was focused on fixed-income trading, because that's where all the money was, and Goldman certainly outshone Morgan Stanley in that environment," FBR's Stelmach said. "A day will arrive when the market will appreciate Morgan Stanley's more diversified business model, and having access to the largest retail distribution network on the planet will be viewed as more of a positive than it is now."

Gorman is likely to have more success in 2011 as the trading environment and retail investor confidence improve and the firm begins to benefit from cost savings in the brokerage joint venture and hiring in its trading unit, analysts said.

"We believe 2011 will be a better year for Morgan Stanley," Doug Sipkin, an analyst for Ticonderoga Securities in New York said in a Jan. 3 note that named the firm as one of his top picks for this year. "The combination of rising interest rates and an improving tone around retail should help."

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