It is a fact of life on Wall Street that wherever the stock market is heading, the shares of investment banks will probably get there first.

Sure enough, as the stock market has plunged in recent weeks, shares of such companies as Merrill Lynch & Co. and Morgan Stanley Dean Witter & Co. have taken a horrific pounding.

Investors are so uneasy about these companies that they were eager to believe rumors Friday that Lehman Brothers, whose stock has plunged 60% from its high, was in such financial trouble that it was near bankruptcy. Lehman Brothers denied the rumors, but its stock still closed the day down.

Lehman's stock now trades at less than book value.

The rumors came days after Merrill Lynch, the nation's largest investment bank, became the latest to report earnings would fall short of expectations. Its stock fell 19% last week. The stock, which once traded at four times book value, now trades at a little over twice book.

According to Financial Services Analytics Inc., shares of 24 securities firms are down an average of 28% since Jan. 1. The Standard & Poor's 500 is up 1.6%.

But investors trying to time a recovery of investment bank stocks in the current environment need to look beyond just the stock market's performance for guidance.

Brown Brothers, Harriman & Co. analyst Raphael Soifer says an ailing corporate bond market both domestically and abroad is the chief source of securities firms' ills.

"Russia and the emerging markets have gotten all the attention, but they're a small part of the problem," he said.

In recent weeks, spooked investors have fled foreign stock and corporate bond markets and headed straight for U.S. government bonds, bypassing high- quality corporate debt and, especially, junk bonds.

For investment banks and commercial banks dealing in high-yield bonds, the rapid retrenchment of the bond market threatens to rattle profits more than the well-chronicled debacles in Russia and other emerging markets. Donaldson, Lufkin & Jenrette was the top junk underwriter through June 30, while Chase Manhattan Corp. was the seventh-biggest and Bankers Trust Corp. ranked 12th, according to Securities Data Co.

Bankers say the decline of the high-yield market is closely related to the stock market plunge.

"When stocks are high, bondholders feel there is equity capital they can get access to. Not so when the stocks fall, and so high-yield dries up," said an investment banker at a firm that issues a lot of high-yield debt.

Of the Wall Street firms that have disclosed July and August results, only Bankers Trust and Salomon Smith Barney have preannounced losses for the third quarter.

Bankers Trust said losses in Russia and other emerging markets probably will wipe out third-quarter earnings. Salomon Smith Barney, a division of Travelers Group (which plans to merge with Citicorp), reported a $360 million loss, one-third of which the firm attributed to losses in the firm's fixed-income arbitrage portfolio.

One firm that may weather the storm best is PaineWebber Group Inc., said Michael Flanagan, an independent securities industry analyst. PaineWebber's fixed-income may be affected by market turmoil, he said, but it does little trading for its account and does few initial public offerings or other investment banking business. Rather, the firm makes most of its money from old-fashioned domestic retail brokerage and asset management.

"Recent events should vindicate PaineWebber's strategy, which has been maligned for several years," Mr. Flanagan said.

However, PaineWebber has not been spared the market's wrath. It's off 41% from its peak, because as investors bail out of stocks and head for safer havens, the tendency is to shed the investment banks first and ask questions later.

"Right now it really doesn't matter" what kind of business a securities firm does, said CIBC Oppenheimer analyst Steve Eisman. "It will be very volatile for some time."

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