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Climbing Too High? by Roz Retkwa

When Dean Witter and Morgan Stanley announced their merger early last year, executives at the companies crowed about the synergies to come from Morgan's underwriting prowess and Dean Witter's distribution capability. The firm also quickly became the largest U.S. securities firm in terms of market capitalization, surpassing Merrill Lynch.So far, the deal is working nicely, Dean Witter brokers report,

When Dean Witter and Morgan Stanley announced their merger early last year, executives at the companies crowed about the synergies to come from Morgan's underwriting prowess and Dean Witter's distribution capability. The firm also quickly became the largest U.S. securities firm in terms of market capitalization, surpassing Merrill Lynch.

So far, the deal is working nicely, Dean Witter brokers report, with vastly improved research and a steady stream of deals--thanks to the bull market.

But by fall, Morgan Stanley Dean Witter's spot as the biggest firm was no more. A new monster was born: Salomon Smith Barney, via Smith Barney's $9 billion (in stock) purchase of Solly. Never mind that Solly was expected to show pretax losses of as much as $300 million in its investment banking business for the prior 12 months. And at the time of the deal, Travelers also said it expected to take restructuring charges of $400 million to $500 million.

Meanwhile, Merrill Lynch continues to pursue its aggressive overseas expansion. It bought Mercury Asset Management Group (104 billion pounds under management) last November for $5.2 billion--in cash. Press reports at the time noted that the price represented a PE multiple of 25, and that the acquisition will cut into Merrill's earnings for up to four years.

Nevertheless, Merrill head David Komansky said the deal represents "a quantum leap towards our goal of becoming a global leader in the asset management business."

More recently, Merrill entered into talks to take over some of the operations of failed Yamaichi Securities Co. of Japan, and is reportedly setting up a 2,000-plus employee operation in that country.

Like Merrill, PaineWebber wants to build its assets. The firm currently has $21 billion of fee-generating assets under management, and "I think we can triple that over the next three or four years," said Mark Sutton, head of the firm's retail division, during a media briefing last December.

All big plans. And why not? Last year, as the market hit new highs, the securities industry achieved another record year, with estimated pretax profits of $12 billion, up from $11.3 billion in 1996, according to the year-end projections released by the Securities Industry Association.

Strong business also creates the need for more brokers. The Street is going full steam ahead on its plans to recruit and train a record number of new brokers in 1998.

PaineWebber, which has about 6,300 brokers, plans on doubling its 1998 training class to 1,200 brokers from 600 in 1997, Sutton said, figuring on about a 40% success rate over three years' time (see "PaineWebber to Institute Tougher Non-compete Agreement," Oddlots, Page 28).

Prudential, with just under 6,000 brokers, trained 1,100 brokers in 1997 and expects to train another 1,400 this year, with an attrition rate of 34% in the first year and a retention rate of roughly 50% after three years, says Jamie Price, president of the firm's retail division.

Smith Barney also is hoping to hire 1,400 trainees during 1998, says Scotty King, the firm's senior vice president and director of training, and it will double the number of branch managers it trains this year to about 100, she says.

Why the Optimism? There are good reasons to be bullish. For one thing, there's still an outside chance that what's been called the "Asian flu" might not affect profits, Price says. "That's the great debate going on right now."

And there's still a fair amount of confidence that corporate fundamentals are stronger than they've ever been and getting stronger.

"There are all sorts of good reasons to believe the market is overdue for a major correction, but by the same token, I've never seen American business in better condition," says Ben Edwards, chairman and CEO of A.G. Edwards of St. Louis. "Good business usually means good markets."

Even if the market drops back, interest rates are still low, making stocks an attractive long-term investment for "a host of baby boomers, who are in their savings, not spending, years," Price says.

Bob Josten of Edward Jones in Newport Beach, Calif., agrees. He notes that anything can happen short term, but "I don't look at just one year, and the next three to 10 years are going to be very good, just from the demographics." The biggest bulk of the U.S. population is the baby boomers, he says, who won't start to retire until 2008 or 2009. In-between, they'll be focused on saving for retirement. "If the market were to drop thisyear, so what? The next 10 years are going to be very good for long-term investing," he says.

A Needed Lesson? So there's good reason for optimism. But Wall Street managements have overexpanded during good times before. Brokers can get carried away, too, depending on what the market is doing.

"I personally think a bear market would probably be good for us in the long run," Edwards says. "An awful lot of people in our business have never seen a bear market. They and their clients may feel that everything will keep going up, but I've always found more opportunity for growth in bad times," he says.

Edwards says he visits about 100 of his branches a year, and when the market crashed in October 1987, about half of his brokers had come into the business since the last bad market prior to 1982. The crash "hurt the brokers worse than their customers; they were more affected by it," he says. "Our brokers were saying: "We can't sell stocks, clients are too shell-shocked." But then I started asking the clients, and nine out of 10 thought it was a buying opportunity," he says. "Then I asked the clients: "What is the broker recommending to you?" and the answer was: "CDs." It was the brokers who were shell-shocked, not the clients."

Much the same situation has developed once again. An estimated 40% to 50% of the industry's current brokers are "new" in the sense that they came into the industry sometime after the October '87 crash, says brokerage analyst Perrin Long, in Darien, Conn.

RR subscriber data from last year show that 48% of readers had been in the business nine years or less, and 21.6% fall into the 10- to 14-year experience category.

That makes for an interesting split between the more seasoned brokers, who were around for the last major break, and their newer counterparts. Where the newer brokers may be lacking in guidance is when to sell a particular stock, Long says, since "95% of all of the stuff that comes out of research departments is buy."

Reps Lay Plans Now Prudential broker Dennis Martino, an 18-year veteran in Clearwater, Fla., thinks what reps really need is expertise on how to hold stocks.

"I think that historically far more money is lost from people worrying about corrections in a bear market than is actually lost in a bear market," Martino says. "I and my clients are longer-term investors. I would not be investing money in the market if I was only planning on being there for a year."

Martino believes that with time, "a more rational market" has developed, with less of an emphasis on short-term gains or losses. "I feel that I've done a really good job of getting the clients to understand that 20%-plus returns are not the norm, that there will be some flat and some down years, and that the key is basically to just stay in," he says.

With new clients, Martino lays the "groundwork right up front. I ask them how they would feel if their portfolio went down 10% or 20%. I try to get some feeling for what the threshold of pain might be. That's the time to have those conversations. You don't want to be having that discussion when the market is down 500 points--that's the time when you want to go back to your clients and remind them of the commitment you made to each other, and to the market, in situations like that," Martino says.

Robin Broomfield, a 13-year veteran with Dean Witter in Anchorage, Alaska, recommends a portfolio mix based on a client's life stage, rather than on the latest market prediction. For clients who are nearing retirement, "I'm getting a bit more conservative" and moving money out of stocks and into other instruments such as convertibles, she says.

But most of Broomfield's clients are younger, with an average age around 40, because "the average age in Alaska is younger," she explains. Therefore, they tend to have a longer-term point of view. Most are focused on college funding requirements or retirement.

But when she flies up to Prudhoe Bay, to visit her clients who work for Arco, what worries her are the non-clients who are playing a do-it-yourself game through Web-based trading.

"I was up there in October, when we had that big drop on a Friday, and there's a cavalier, devil-may-care attitude, sort of tossing it off as 'no big deal' because they really haven't felt it. The market has been back up in two or three or four days," she says. "But what happens if the market is down for a month or two or three?"

One of the problems that a bull market creates, Price says, is that "a lot of people start to believe they're geniuses." But whenever the market goes south, that's "when full-service brokerage has always shined," he notes. "We've had what is probably one of the best four-year periods on record, and people have gotten into thinking it's an easy game to play, but it's not that easy."

Josten knows about that. "I had a guy who wanted to sell everything out this morning [Jan. 12] when the market was down 150, and I talked him out of it," says Josten. "Now that the market is up 40, he's glad he didn't."

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