In the wake of the Federal Reserve’s 50-basis-point cut in its fed funds target rate earlier this week, one Wells Fargo analyst is cutting his outlook on the brokerage sector.
Christopher Harris, senior analyst at Wells Fargo Securities, issued a report Friday that lowered per-share earnings estimates for brokerages next year, on average, by 12%. The most significant declines are expected at the electronic brokers.
The report also slashed share price estimates by 22%.
Mr. Harris changed his outlook on the broker sector to negative from neutral, according to the report. Raymond James Financial Inc., for example, was updated to an “equal weight” position from “overweight.”
Stock prices of financial firms are extremely volatile when interest rates shift. Broker-dealers make significant revenue from clients’ cash, including margin loans and cash sweep deposits. When short-term interest rates drop sharply or even remain at zero — as they did for years after the credit crisis — brokers take a hit to their bottom lines.
“Our broker coverage is particularly sensitive to interest rates, as interest-sensitive revenues account for 60% to 70% of the total at e-brokers and 20% to 30% at broker-dealers, less adviser payouts,” Mr. Harris wrote.
“Even though we think investors should steer clear of financials that are dependent on [interest rate] spread-based revenue, we are not recommending a blanket ‘underweight’ on the group,” he wrote. “This is partly because the stock prices have already declined so materially.”
“While [Raymond James Financial] has good business diversity, it is difficult for us to justify an ‘overweight’ rating given our expectations for more Fed rate cuts this year and negative [earnings per share] revisions,” he noted.
For Mr. Harris, more bullish prospects include stock exchanges that benefit from market volatility and alternative asset managers, which are generally not impacted by lower rates.