Market fireworks spark profit fallout for brokerages
The brokerage industry is astraddle the bull market.
Soaring volume and rising prices are quickly finding their way to the bottom line at the brokerage houses. When they report their third-quarter earnings in the next few weeks, securities analysts expect to see some excellent results. The third-quarter earnings will include the August run-up in the market and the volume records established then. If the current market surge continues and volume remains at its record-breaking levels, the fourth quarter will likewise be good. Thus, the industry will salvage what many analysts expected to be a lackluster year.
For those brokers who are still independent and publicly listed, this good news has already been translated into higher stock prices. For instance, since early July, Merrill Lynch & Co. stock has climbed from $21 a share to $40 as of late last week; Donaldson, Lufkin & Jenrette Securities Corporation, from $8 a share to $15; and First Boston Corporation (OTC), from $37 to $65. Other publicly listed companies, including E. F. Hutton & Co., Paine Webber Inc., A. G. Edwards & Sons Inc., and Inter-Regional Financial Group Inc., have made similar moves.
Despite this action, Joel Rosenthal, a vice-president at Jesup & Lamont Securities Company, a small brokerage, who recommended the stocks at their July lows, says they may not have fully discounted all the good news. He says ''it's possible in a bull market that volume could continue at 90 to 115 million shares per day.''
He says that to have such a bull market, the Reagan administration must get the economy moving again, keep the inflation rate low, and see that interest rates continue to fall. In that kind of environment, he says, ''both the consumer and business will continue to reliquefy, and this is the ideal market environment for stocks and bonds. You could see one of the greatest bull markets in this century. Have the brokerage houses discounted this? Absolutely not.'' But he adds that it might pay to be cautious about the market as the November election nears.
Joseph Spivack, an analyst with the Value Line Investment Survey, agrees that in the short term the brokerage industry looks very attractive. But, he adds, ''this industry is very volatile.'' He believes that the brokers' profitability runs in four- to five-year cycles and that the next big peak in earnings will be in 1984. But he hedges his comments, adding, ''That doesn't exclude the possibility of local high points like the third quarter and possibly the fourth.'' He warns investors that brokerage stocks ''are fun if you can tolerate the risk. But don't put the dress fund in it.''
The brokers stand to gain not only from soaring stock volume, but also from selling fixed-income instruments, such as bonds and bond funds. ''The decline in interest rates,'' says Mr. Rosenthal, ''is a bigger factor than the record volume.'' He notes other brokers will have huge profits from trading bonds and stocks for their own accounts.
And for some of the brokers, mergers may still be a possibility as the financial markets are deregulated. ''The trend toward financial giants is continuing,'' Rosenthal says, ''and some of the brokers might benefit by being taken over.'' He expects brokerages would prefer to merge with banks rather than insurance companies, since they would have a better fit with their products.
To William S. Doane, it's the ''march of the Generals.'' Mr. Doane, a market strategist at the Fidelity Group, a Boston-based mutual fund, has made his own version of the Dow Jones industrial average. Instead of being composed of 30 industrial companies, it's made up of companies with ''General'' in their first name: General Electric, General Foods, General Mills, General Motors, General Telephone, and General Tire.
According to Mr. Doane, from a technical standpoint, his average has ''broken out'' from its 1967-82 levels (see chart). To him, the breakout level is the same as if the Dow had shot past the 1,000 mark. He says that from a strictly chartists', or technical, standpoint, the August surge (and the recent October burst) are ''the beginning of an advance that could carry well into and through 1984.''
From a nontechnical standpoint, he says, ''we could be seeing an expansion of price-to-earnings ratios,'' especially if the economy stays sluggish. Stock prices might rise if earnings don't, as investors decide it's worth paying a higher premium for stocks.
Furthermore, he notes, portfolio managers have avoided investing in the big blue chips for the past several years. This leads him to wonder if these types of companies are underrepresented in institutional portfolios. And, he asks, ''With the foreign companies walking all over the US companies with their imports, could this be a subtle shift back to a 'buy America' philosophy?'' Even though Doane's average is made up only of ''Generals,'' he says these types of companies are alternatives to other consumer-cyclicals. The product mix of the ''Generals'' breaks down to 70 percent consumer related, 15 percent cyclical, and 15 percent utility. Other, similar companies (maybe Admirals instead of Generals) are Eastman Kodak, 3M and Procter & Gamble.
The stock market soared last week, propelled by lower interest rates and investors' desire not be left out of the bull market. For the week, the Dow Jones industrial average climbed 79.11 points, closing at 986.85, its highest level in more than 15 months.