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Sector Spotlight: Broker-Dealers
By Price Headley | Published  10/24/2005 | Stocks | Unrated
Sector Spotlight: Broker-Dealers

In Donald Trump's wildly entertaining and otherwise useless book, The Art of the Comeback, he encourages us all to "get even!".  Now is the chance to make money off the same firms that have been profiting from investors for decades, and as the Donald says, "get even!"

We've been watching the recent run-up in the Broker Dealers (best represented by the AMEX Broker Dealer Index- XBD) with drool on our mouse pads. Despite the recent climb, the brokers remain cheaper than a bag of peanuts, particularly the National Brokerages which have an average P/E ratio of 14, while the S&P 500 P/E sits at around 19.

On top of major bullish technical indications, there have been numerous mergers rumors as well. Morgan Stanley in particular has been said to be close to the auction block. This comes only months after Legg Mason sold its brokerage business to Citigroup as well as a slew of other mergers and acquisitions in the industry.

Another note of promise is the nature of markets in general. We saw investors roll their money into REIT's as the market tumbled during the recent bear market. In the last 12 months on the other hand, XBD has gained over 30% while the S&P 500 has managed a measly 6% gain. The reasoning behind this is simple, when the market is doing well, the brokers do well because of renewed or continued interest in the market.  If we see a major drop in REIT's and regular real estate, we could very well see the same rolling over of cash into equity markets which would inevitably lead to further gains in the XBD.  Let's take a look at the technicals that caught our attention in the first place.

Keep an Eye Peeled

One of our most effective indicators - Moving Average Convergence Divergence (MACD) - is employed here. The blue line in the top chart represents the 20-day simple moving average. We are looking for the fast red line in MACD (lower chart) to cross over the blue one signaling bullishness. To be safer, we are looking for a confirming close above the 20-day moving average in the index on bullish MACD signals. This has proven effective before, and so we are watching today's close and perhaps the next few days closely as well. You can see that XBD has just crossed over the 20-day line and MACD is about to cross over as well.

AMEX Broker/Dealer Index (BDX) - Daily

We are mindful of downside risk though. One thing we want to keep in consideration is the potential widening of credit spreads. Also, rising interest rates could be detrimental, particularly to broker/dealers that engage in much fixed income underwriting.

In summary, we are bullish if the MACD crossover confirms our initial expectations in the short-term. In the long term, we are looking for a lofty price target of 235 (based on our belief that the broker-dealers will return to a similar valuation as the S&P). Again we must be mindful of fundamental and technical indicators. Always trade with a plan and discipline - trade well!

Price Headley is the founder and chief analyst of BigTrends.com.