(November 21) – Merrill Lynch has cut its earnings forecasts for U.S.-based financial firms. The big problem is the choppy equity markets, say Merrill analysts.

The firm has lowered its projections by 7% on average. Weak markets, coupled with telecom loan exposure, the deteriorating credit market, and minimal non-U.S. deal flow, are the primary culprits.

“We believe a creeping trend toward illiquid financial markets is fast becoming the dominant theme for financial stocks, and we recommend investors stay under-weighted in financial equities until the Fed moves decisively to lower interest rates and re-liquify the financial markets.”

Merrill is unwilling to call for a rate cut just yet. “We think this notion is dangerous short term if a Fed ease is in fact delayed by a number of months. In essence, we believe investors have yet to fully react to the unfolding credit cycle, and that considerably more earnings pain may be experienced in many financial stocks before rates in fact start coming down.”

Bank of New York, Chase Manhattan, Citigroup, Mellon Financial and Wells Fargo get high marks for the long-term. “Shorter term, however, our focus is on the broadly deteriorating picture for earnings across a widening array of financial service companies.”

On this basis it is cutting its call on T. Rowe Price and Janus Funds owner, Stilwell Financial by 10% and 13% respectively. It has previously assailed Stilwell for its recent poor performance in the Janus funds and the weakness in the direct model. While the firm is generally quite negative, the one name it doesn’t mind is Franklin Resources, owner of the Templeton funds.

Merrill may not be being as tough as it should be. “Our median broker dealer estimate is under consensus but still may not be conservative enough: Our trend reversion model suggests consensus broker dealer estimates may be 25-50% too high assuming revenues next year were to revert 50-100% of the way back toward a 5 year trend line.”

“We suggest investors remain under-weighted in these segments until the Fed begins to lower interest rates and reverse what appears to be a creeping trend toward illiquid markets currently.”