(For more on analysts' outlook for U.S. financial institutions, double-click on [ID:nBNG327142]) (Adds share prices)
By Tenzin Pema
BANGALORE, May 22 (Reuters) - Veteran bank analyst Richard Bove told clients to sell shares of Goldman Sachs (GS.N), Lehman Brothers LEH.N and Merrill Lynch MER.N, warning that big investment banks would be slammed by an economy slowed by rising energy prices and rising rates.
The analyst, who made news in late March when he declared that the U.S. financial crisis was over, on Thursday cut his 2008 outlook for these three investment banks as well as Morgan Stanley (MS.N), but maintained a "neutral" rating for Morgan.
Brokers have been helped in recent weeks by signs that the credit crunch was bottoming out. But Bove, now an analyst with Ladenburg, Thalmann & Co, predicted in a research note that investment bank stocks would decline this summer on weak earnings, a cloudy outlook and seasonal weakness.
At the same time, crude oil soaring north of $130 per barrel will put more stress on U.S. consumers and could fuel inflation.
"While I remain convinced that the stress on the financial sector has been alleviated, I am just as convinced that the pressure on the economy has not eased," Bove wrote.
Lehman Brothers Holdings Inc shares were down 2.9 percent, Merrill Lynch & Co Inc was down 1.7 percent and Goldman Sachs Group Inc shares were 1.5 percent lower in afternoon trading. Morgan Stanley shares were off 0.2 percent.
Nearly a year ago, Bove was one of the first banking analysts to recommend selling financial stocks as credit market problems began. Last July, he correctly predicted the booming growth of the financial system could not be sustained by economic growth.
In more recent months, pressures on the brokerage industry have risen because of the economy, slowing investment banking activity and, perhaps most importantly, more evidence of faulty risk management.
"In the current quarter, it appears that the brokers have not judged risk appropriately once again," Bove said, adding that brokers have been shorting popular financial indexes against real world cash holdings. "The hedge is not working," he said.
Brokers for several years had benefited from growth of hedge funds as well as the expansion of the mortgage markets, trends no longer fueling Wall Street earnings.
"None of these factors are present at the moment and none of them will be robust for the next few years," Bove said.
He expects that the mortgage markets may take five to six years to recover, and said that hedge funds do not want to borrow aggressively in down markets when most lenders are tightening their purse strings.
LOSSES FROM HEDGING
Bove is the latest in a string of Wall Street analysts to forecast investment bank losses from ineffective hedging. The cash-market values of many financial instruments have diverged from indexes meant to mirror cash.
Also on Thursday, Fox-Pitt Kelton analyst David Trone forecast a second-quarter loss of 34 cents a share for Lehman Brothers, down from his previous estimate of a $1.48 profit.
"For the first time since the credit bust began, Lehman may post a loss in the second quarter, as it gives back a bit of its huge hedging gains from the last few quarters, as certain key indices rallied," Trone said.
Trone rates Lehman shares "outperform" and sees them trading at $62 within the next year.
The Amex Securities Broker-Dealer Index .XBD, which was trading just barely lower on Thursday afternoon, has fallen 20.7 percent this year as the effects of the subprime mortgage crisis, credit crunch and housing slump reverberate.
The following are Bove's ratings, price targets and estimate changes for the Wall Street investment banks: COMPANY RATING PRICE TARGET 2008 SHR VIEW 2009 SHR VIEW
Current Prior Current Prior Current Prior Current Prior Goldman Sachs Sell Neutral$151 $203 $13.96 $14.39 $20.50 $20.58 Lehman Brothers Sell Neutral $35 $38 $2.07 $2.36 $3.50 $3.48 Merrill Lynch Sell Neutral $39 $49 -$0.11 $1.37 $3.44 $3.68 Morgan Stanley Neutral Neutral $41 $53 $4.77 $5.98 $5.24 $6.30 (Additional reporting by Joseph Giannone in New York; Editing by Richard Chang and Gerald E. McCormick)