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Industry Outlook -- Finance: SECURITIES

SECURITIES

Profits won't meet last year's lavish levels, and brokerages are antsy about a possible market correction. One gambit: Go overseas

The market's rapid rise generated generous fees and commissions. That plus record levels of mergers and acquisitions and initial public offerings helped pretax profits reach an estimated $11.5 billion, the highest ever. "This is heaven," says Salomon Brothers Inc. analyst Thomas Facciola. "It doesn't get any better."

That sort of triple witching year is unlikely to repeat, though. Assuming that rates stay low or even nudge down slightly, BUSINESS WEEK estimates that pretax profits will slip to $6 billion to $8 billion, as stock issuance and the market slow down. Before 1996, the industry's best year was $8.6 billion in 1993.

BIG DIVE? Of course, the picture could change if stocks take a big dive. "This is a bull market that is unprecedented in terms of its length and the amount of its upward movement. In 1997, there could be a correction of as much as 15%," says Herbert M. Allison Jr., the Yale philosophy graduate who becomes president of Merrill Lynch & Co. this year. Merrill has contingency plans in case the market reverses. And some analysts are even more downbeat about 1997.

Record profitability has translated into record prices for many brokerage stocks. The Financial Service Analytics Index of 29 brokerage stocks was up 45% through Dec. 20, 1996, on top of a 37% gain in 1995. And a number of brokerages are trading at or over two times book value, despite a historical trading range that is closer to book value. Indeed, the rule of thumb for the industry is to buy at book value and sell at two times.

That rule of thumb may be outdated. One reason brokerage stocks have soared is takeover talk. This could be the year that Wall Street starts to be gobbled up by commercial banks. True, there has been talk of consolidation for ten years. But late in 1996, the Federal Reserve loosened the historic limitations on banks underwriting securities, which could spur banks' acquisitions of brokers. This would unsettle brokerage executives, but their firms may get their own perks from Washington. A capital-gains tax cut may be in the works if Congress agrees on a balanced budget plan. And down the road Social Security may be partially privatized.

If things become a little tenuous at home, executives can go looking for prospects overseas. Merrill Lynch is snapping up brokerage firms from Australia to Spain. Other firms are establishing joint ventures abroad in hopes of gaining a local foothold. Already, roughly half of Morgan Stanley & Co.'s revenues come from outside the U.S. At the moment, many traders and bankers are delighting in their eye-popping bonuses, which are expected to run about 30% to 50% higher than the year before. But 1997 looks like a good year to tuck away a little of that windfall--just in case.By Leah Nathans Spiro in New YorkReturn to top

TABLE

Prognosis 1997

POSITIVES

-- Low interest rates will continue to fuel the sale of equity mutual funds

-- The mergers and acquisitions business will remain strong

-- Growth outside the U.S. will be strong

NEGATIVES

-- After five years of rapid growth, the securities industry may be running out of steam

-- Investment banking as well as equity sales and trading are plagued by overcapacity, which hurts profit margins

-- If small investors approach the stock market these days with an odd mixture of elation and fear, Wall Street denizens are feeling mostly euphoria. Return to top


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