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FINANCE STOCKS: WHAT COMES AFTER NIRVANA?

Banks, brokers, and insurers look like market-beaters, even if the big runup is over

Investors who bet on the U.S. financial-services sector in 1996 can laugh all the way to the bank. For the second straight year, most of the group is set to beat the overall market. A third spectacular year is too much to expect, but if interest rates stay low and takeovers continue apace, the sector is likely to outperform the market again.

Take commercial banks. ''The fundamental story is that the market is repricing banks. Prices will go up and up,'' says Gerard L. Smith, managing director at UBS Securities Inc. Not everyone is so bullish, but a healthier industry has made investors rethink the traditional discount to the market of bank price-earnings multiples. ''The market feels comfortable with the quality of bank earnings,'' says Frank V. Cahouet, chairman of Mellon Bank Corp. ''The bias [of bank stocks] will be up in 1997.''

Through Dec. 16, the Keefe, Bruyette & Woods Inc. bank index had risen 29.9% after a 49.7% rise in 1995. Share buybacks have been rampant--expect more in '97. ''I'm a bull,'' says Keefe Managers CEO Harry V. Keefe Jr. He says low inflation helps banks, as does their greater efficiency. While profit trends look good, if the economy falters, credit quality and stock prices could hurt. But, says Keefe, ''I don't see where the bad news on loan problems is going to come from.''

MIXED RECORD. So which stocks to choose? David S. Berry, research director at Keefe Bruyette, likes Chase Manhattan Corp., for its profit boosts into 1998 from cost cuts, and Citicorp, which is set for revenue growth. Analyst Charles M. Vincent at PNC Bank Asset Management Group sees no fireworks in financial-services stocks but says some picks, such as Norwest Corp., will thrive. Salomon Brothers Inc. analyst Michael A. Plodwick says the best potential takeover plays are Mellon, Summit Bancorp, Huntington Bancshares, First American, KeyCorp, Firstar, and U.S. Bancorp. James K. Schmidt, portfolio manager for John Hancock Regional Bank Fund, finds Union Planters and First American attractive targets.

Brokerage stocks should do well, but it will be hard to beat their 37.78% rise through Dec. 16--or 1996's strong profits. ''That kind of nirvana doesn't happen every year,'' says analyst Raphael Soifer at Brown Brothers Harriman & Co. He likes Merrill Lynch & Co., since it outpaces a rising market. By contrast, Donaldson, Lufkin & Jenrette Securities Corp. analyst--and bear--Joan S. Solotar counsels: ''Stick with Morgan Stanley. It tends to do better in a downturn.''

Insurance stocks had a mixed record in '96--with most life insurers beating the market and many property-and-casualty firms hurt by storm losses, says DLJ analyst David Seifer. One firm he likes is American International Group, a consistent earner with a strong global franchise. On the life side, he favors Jefferson-Pilot Corp. and SunAmerica Inc. William W. Dyer, a trustee of Century Shares Trust, likes Aon for becoming the top insurance broker and slicing costs and Chubb Corp., since it may sell units and buy back shares. USF&G Corp. is appealing for that same reason and, he says, because it may be takeover bait.

Don't forget speciality finance companies. Berry likes mortgage lender GreenPoint Financial; First Merchants Acceptance, a subprime auto lender with profit momentum and sound credit quality; and credit-card issuers--especially Capital One Financial, which has dodged big losses from record bankruptcies.

Not all believe the market--or financial services--can keep rising. But in '97, bulls again may have the last laugh.

By Alison Rea in New York



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