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COMMENTARY: LOWER INTEREST RATES GIVE INVESTORS REASON TO PAUSE

FOR THE WEEK, THE DOW JONES sank 212 points, or 2.3%, to finish at 8989.

THE S&P 500 dropped 20 points, or 2.0%, to end at 976.

AND THE NASDAQ fell 20, or 1.2%, to close the week at 1625.

INVESTORS TOOK A BUYING BREAK THIS WEEK, sending all three major indices lower. Investors traded cautiously, wondering if the Fed would cut rates by 25 or 50 basis points. Whatever it was they were looking for, investors didn't seem to find it in the Fed's 25 basis point decision on Wednesday. Stocks finished down, with the declines ending four-week rallies in the Dow and the S&P 500.

Some say that a 50-point cut might have been priced into stocks, rendering Greenspan and company's cut disappointing. That could be it, but we're also hopeful that perhaps people are beginning to ask themselves why they expected any rate cut to do anything more than the last 12 rate cuts have done. In other words, what did they expect 25 basis points to do this time that several hundred couldn't do over the last couple of years? Perhaps as they mulled this over investors began to wonder why the heck they've been pumping up stocks for so long.

Last week we explained why there is no logical case for market rally. Too many clouds hang over both the economic and corporate scenes, and reports this week -- like those just about every week -- reinforced that view. Look again at the economic side. Last week we learned that:

-- Durable Goods Orders declined
-- New Home Sales hit record highs
-- GDP Growth was revised downward
-- Jobless Claims fell to three-month lows

In the short term we can tidily summarize these results as bad, good, bad, good. But taking a broader view they do nothing to bring any clarity AT ALL to the economic picture, no matter what economists want you to believe. These are simply a replay of the numbers we've been seeing for the last few years: A couple of bright spots in an economy stuck in a dark night. (We should add that we don't necessarily see higher new home sales as a bright spot, either. Right now it is the crutch upon which the economy is leaning, but this market is looking bubbly. The housing market could pop or just as easily run out of air when the Fed runs out of interest rates to cut.) As to the promised second-half recovery, well, we see no economic, and very little earnings evidence to support the predictions. Wishful thinkers have pointed to monetary and fiscal stimuli and expect to be given the benefit of the doubt that a recovery is nearly upon us. Certainly tax cuts and lower interest rates could create a pop in consumer spending, but not a sustainable one. Nor would they do much to correct the fundamental problems dogging the economy.

On the corporate side, mixed earnings news last week did little except undermine current valuation levels even further. We saw more earnings warnings, as well as some quarterly reports that disappointed analysts. And yet investors didn't seem too eager to take these announcements to heart. They backed off a little bit this week but not much.

It could be that with savings accounts and money market funds paying almost nothing, investors have nowhere else to put their money but into stocks. Many are probably still trying to "catch the wave" of this latest rally. Or it could be, as we have noted previously, that investors are looking past 2Q earnings and waiting for 3Q pre-announcements and results to see if that elusive second-half recovery actually shows up. Or it could be that investors, just like Alan Greenspan and company, are biding their time until the next Fed meeting in August, hoping that between then and now something great happens.

All of this hoping and waiting could get unhinged, of course, if during earnings season we see too many warnings or lukewarm earnings reports -- or, if the economic data don't show marked improvement. But if the good news, or more likely the so-so news, outweighs the bad, then don't be surprised to see this market move higher in anticipation of another Fed interest rate cut later this summer. It won't be a smart rise, but so far that hasn't been a prerequisite.

Prepare for a fresh round of economic data, as well as more corporate earnings.



ECONOMY WATCH

1. A DECLINE IN DURABLE GOODS ORDERS
The Commerce Department reported on Wednesday that Durable Goods Orders fell 0.3% in May, the number's third drop in the past four months. Economists expected a 1% increase after orders sank 2.4% in April. What a miss! Core orders -- which exclude defense and aircraft goods and are seen as the most accurate monthly measure of capital spending -- fell 0.5% after a stiff 2.6% drop in the previous month. Over the past 12 months, orders are down 0.3% to their lowest level since last June.

What does this tell us? That companies are still reluctant to spend. And as you know, business spending is the real key that will unlock this economic recovery.



2. NEW HOME SALES SET RECORD
New Home Sales surged 12.5% to a record annualized pace of 1.16 million last month, according to the Commerce Department on Wednesday. The old record was 1.06 million, set last September. The jump in May sales was the largest monthly percentage increase in nearly a decade. The figures surprised economists, who expected a rise to just 1.03 million. Who ARE these experts? [Gosh, we wish we could get away from these EXPECTATIONS.]

In other housing news, the National Association of Realtors reported that Existing Home Sales rose 1.2% to an annualized rate of 5.92 million units. Record low mortgage rates have been the driving force behind the sizzling housing market. And with the Federal Reserve's 25-bp interest rate cut, expect mortgage and refinancing activity to continue. That's a good thing, since it puts money into the hands of consumers.



3. GDP GROWTH REVISED DOWNWARD
The economy wasn't as healthy as previously expected. The Commerce Department on Thursday released its latest estimates of 1Q Gross Domestic Product Growth: A 1.4% annualized pace. That's half a percentage point lower than previous estimates, as inventories grew less than expected and imports grew more. But the more troubling revision was in personal incomes, which were revised downward for both the fourth and first quarters.



4. JOBLESS CLAIMS FALL TO THREE-MONTH LOW
The job market has started to show signs of life. After weeks and months of rising Jobless Claims, the Labor Department reported on Thursday that Initial Claims fell 22,000 to 404,000 -- their lowest total since March and barely above the key 400,000 mark. The four-week average, meanwhile, fell by more than 5,000 to just above 428,000. We still need to see a lot more improvement before we truly see an improving job market, but the latest data shows that the economy has taken a step in the right direction.



MARKET MOVERS

I. TENET HEALTHCARE PUTS ITS EARNINGS ON LIFE SUPPORT
Hospital operator TENET HEALTHCARE (THC, $11.65, down 4.58) was the latest big company to warn of lower quarterly earnings. Higher medical costs and lower payments from insurers caused the firm to impose a drastic cut in 2Q earnings projections. Tenet earned just 2 cents a share during the first two months of the quarter, making it virtually impossible for the firm to reach earnings estimates of 34 cents. For the 12 months beginning next quarter, the company expects to earn 90 cents, well short of the $1.45 that analysts expect.

Even though Tenet cleaned house and forced its troublesome CEO to resign, problems have remained for the company. Along with higher medical costs and lower insurance payments, the firm faces a shortage of nurses, rising salaries, and increased competition from physician-owned treatment centers. The inability of Tenet to overcome these hurdles is what we were afraid of, and why we removed the stock from our Healthcare Portfolio in October. The stock, which traded at $32 back then, has fallen a gut-wrenching 63% since we removed it.



II. FREDDIE MAC FALLOUT HURTS FANNIE MAE
FANNIE MAE (FNM, $66, down 4) shares took a 3% hit on Monday, as large investors and accounting experts looked through the mortgage finance firm's financial reports with an eagle eye. According to the New York Times, when accounting for Fannie's assets at fair value, the experts found that the company suffered billions of dollars of losses in 2002 due to falling interest rates. Current accounting rules allow the firm to hold off from immediately reporting investment losses. The increased scrutiny on Fannie's statements is a direct result of the questions surrounding FREDDIE MAC (FRE, $50, unch.). Freddie could be faced with a similar situation, although the company was seen as the more conservative of the two and likely hedged itself more thoroughly than Fannie against interest rate swings.



III. THE BEWITCHING EFFECT OF HARRY POTTER MANIA
As many people expected, the new Harry Potter book that hit the shelves on midnight Friday sent kids and their parents scrambling to get their copies, setting new sales records in the process. The fifth book in the widely popular series, "Harry Potter and the Order of the Phoenix" flew out of the 630 BARNES & NOBLE (BKS, $23, up 1) stores at a rate of 80 books per second. The bookseller sold nearly 900,000 books on the first day, leading the firm's CEO to call June 21st "the biggest single day of sales of any book in history." But B&N wasn't the only company to profit from the book's huge success. BORDERS GROUP (BGP, $17.54, up 0.66) sold 750,000 copies on Saturday, the highest first-day sales total of any book in its history, too. And AMAZON.COM (AMZN, $36, up 1) said that it shipped one million copies worldwide.

As for the book's printer, SCHOLASTIC (SCHL, $30, down 1), the better-than-expected sales have people asking if the company will increase production of the book from its planned 8.5 million first- and second-run total. The firm estimates that the book already sold 5 million copies, a total that Scholastic said would break "all publishing records." But if the company doesn't have enough supply to meet the demand, then it could let a prime profit-making opportunity slip away. That's the reason for investor skittishness that caused the stock to fall 5% Monday.



IV. GOOD NEWS, BAD NEWS IN THE TECH SECTOR
Action in the Nasdaq was mixed throughout the week, in large part to mixed messages from some companies in the sector. CORNING (GLW, $7.50, down 0.40), a leading maker of the fiber-optic equipment that forms the backbone of the information superhighway, reaffirmed its 2Q earnings projections. The company remained adamant about its forecast -- which ranges from a loss of two cents a share to a penny profit on $730 million in sales. Corning also said that it will reach profitability, if not this quarter then later this year.

On a down note, however, chipmaker ADVANCED MICRO DEVICES (AMD, $6.38, down 0.41) warned that sales for the current quarter will fall short of estimates. You probably only need one guess to figure out the reason. That's right: SARS. AMD expects to generate $615 million in revenue, a full $100 million below the firm's earlier projections and even further below Wall Street expectations of $725 million. Barring any miraculous restructuring efforts in the next few weeks, profits will follow sales to the downside. Is SARS truly that damaging, or are companies just using the disease as an excuse to disguise other non-related shortfalls? We don't know, but that makes at least five big-name companies that have used the SARS defense. We fully expect even more firms to do the same between now and 2Q earnings season.



V. NEW NAME, SAME OLD STORY FOR ONE TECH FIRM
The company that owns a number of popular websites -- including EXPEDIA (EXPE, $74, up 1), Hotels.com, and Ticketmaster -- underwent a name change beginning Tuesday. Formerly known as USA Interactive and trading under the ticker symbol USAI, the firm will now be called INTERACTIVECORP (IACI, $39, up 1). We used to own the stock, but we removed it from our Technology Portfolio because of our belief that the whole sector is overvalued. The company's new moniker doesn't change our opinion. We still suggest investing in other sectors, such as Healthcare or Mortgage REITs.



VI. IMPORTANT CHANGES TO ONE ECONOMIC INDICATOR
Earlier this month the Bureau of Labor Statistics (BLS) released its May Employment Report, a key economic indicator on which economists and investors alike kept a close eye. In fact, not only did U.S. investors mull over the data, but the report made waves in financial markets from Europe to Asia.

But the latest report introduced changes to its method of measurement, resulting in revisions to jobless data for the past few years. The BLS enacted more accurate state job tallies and added new sampling techniques and seasonal adjustments. So what happened to the data? More recent losses were pared -- such as December's huge total of 343,000 job losses, which was downwardly revised by 240,000. This tells us that the job market may be stabilizing.

However, the new measuring method restated the total number of job losses from March 2001 to the end of 2002, from 2.4 million to 2.9 million -- a huge 500,000 jump. That means the recent recession was deeper than we thought. Just something to think about the next time you're convinced of a second-half economic recovery.



VII. A HUGE RESTATEMENT FROM FREDDIE MAC
After weeks of speculation, Freddie Mac finally offered some comments about its earnings restatement and alleged accounting problems. The mortgage finance firm, which was hammered two weeks ago when it sacked its top management, announced that the profit revision will add up to $4.5 billion to earnings from years 2000-2002. The company also admitted to mistakes in its accounting methods, saying that weak controls and a lack of expertise led to "numerous errors" in its financial statements.

Freddie admitted that it engaged in practices that smoothed out earnings, referred to as "cookie jar" accounting. Now that the firm has addressed these issues, Freddie expects future results to be more volatile from quarter to quarter. The firm will release a public review of its accounting practices sometime next month.

At least we know -- for now -- that Freddie's accounting issues weren't related to artificial profit inflation, like Enron and WorldCom. But this issue is still troubling. Freddie will restate revenues anywhere from $1.5 billion to $4.5 billion. That's a HUGE range, due to the complexity of the derivatives investments involved. The SEC and the Justice Department are investigating the firm's practices, and hopefully they don't uncover any other wrongdoing. We believe Freddie, so we still recommend holding the stock, and even adding to your position. But if you're not at all comfortable with this new, excessive risk, then by all means put your money somewhere else.



VIII. GOLDEN EARNINGS FROM GOLDMAN SACHS
Goldman Sachs Group reported a 23% jump in 2Q earnings, as a higher risk tolerance allowed the firm to achieve higher earnings. The investment bank posted net income of $695 million, or $1.36 a share, vs. a year-ago profit of $565 million. Results easily topped analysts' estimates of $1.19. Revenue rose slightly, from $3.9 billion to $4.0 billion. Goldman raised its daily value at risk from $53 million in the first quarter to $59 million last period -- its highest risk level since the company went public a few years ago. With a higher tolerance for risk, the firm was more able to profit from the favorable fixed-income environment. Fixed-income revenue surged 39% to $1.6 billion. To top it all off, Goldman more than doubled its quarterly dividend, to 25 cents a share from 12 cents. However, the stock fell 2% on the solid earnings news.



IX. VERIZON LETS GOVERNMENT'S CALL GO THROUGH
Want to change cell phone plans but don't want to change phone numbers? You may soon be able to do just that. VERIZON'S (VZ, $40, down 1) wireless unit dropped its opposition to a proposal voiced by the government to allow customer to bring their phone numbers with them to new carriers. Verizon Wireless was the staunchest opponent to the rule, which will go into effect on November 24th. However, other wireless firms like Cingular Wireless and AT&T WIRELESS (AWE, $8.39, up 0.46) will continue to fight the law. But with Verizon out of the way, it makes the law more likely to stick come November. Then consumers' revolving door of phone numbers may finally grind to a halt.



X. STRONG DEMAND FOR REIT IPO'S
The largest IPO of the year hit the market on Wednesday. AMERICAN FINANCIAL REALTY TRUST (AFR, $14.85, up 0.60), a REIT which owns bank buildings across the country, was expected to be priced in the $11-13 range. Shares were finally priced at the high end, at $12.50 a share, and they closed Wednesday afternoon at $14.25 -- a 14% gain. The company is still young and untested but in the first quarter of the year, American Financial made $3.3 million on $15.7 million in revenue.

But the stock's impressive one-day gain shows us how strong the demand is for REITs. In fact, it was one of two REITs to debut on Wednesday, along with MAGUIRE PROPERTIES (MPG, $19.15, up 0.15). The two firms raised $1.4 billion, more than the total raised from this year's previous eight IPO's combined. American Financial raised $700 million alone from its 56 million share offering.

We cover the best part of this news in The Bull Market Report Daily. If you're not already a subscriber, click here to SAVE $20 on a new subscription.



XI. BETTER-THAN-EXPECTED, BUT STILL DISAPPOINTING RESULTS FOR 3COM
3COM (COMS, $4.76, down 0.26), a network equipment maker and CISCO SYSTEMS (CSCO, $16.89, down 1.04) rival, posted a wider net loss than in the same quarter last year. The company posted a fiscal 4Q (ended May 30th) loss of $40 million, or 11 cents a share, vs. a year-ago profit of $25 million, on a 41% sales decline to $175 million. However, results were a penny better than expected. 3Com took a stiff $55 million restructuring charge, as the company slashed 10% of its workforce and moved its headquarters from Silicon Valley to Massachusetts. Yet another example of a Tech firm stuck in a rut.



XII. LEHMAN BROTHERS TO MANAGE MONEY
Investment bank LEHMAN BROTHERS (LEH, $75, down 6) is close to buying NEUBERGER BERMAN (NEU, $39, up 4), a leading money-management firm. Under the deal Lehman would pay $3 billion in a combination of stock and cash. The acquisition would vault the bank, which has focused primarily on corporate finance and bond trading activities, into retail asset management -- allowing the firm to compete more directly with larger firms Morgan Stanley and MERRILL LYNCH (MER, $47, unch.). Neuberger has $56 billion under management!

This is a stark change in strategy for the firm, which has a history of selling off individual investor accounts. If it becomes official, this will be the third money-management acquisition of the week, following CHARLES SCHWAB'S (SCH, $10.39, down 0.44) acquisition of STATE STREET'S (STT, $39, down 1) private management business and the AMERICAN EXPRESS (AXP, $42, down 1) purchase of British firm Threadneedle Asset Management. It looks like these firms expect a return of individual investors and an inflow of capital into the stock market.



XIII. NIKE TRIPS ON EARNINGS ESTIMATES
Leading shoemaker NIKE (NKE, $53, down 3) reported an 18% rise in quarterly earnings, led by strong international sales. The company reported 2Q net income of $245 million, or 92 cents a share, vs. a year-ago profit of $210 million. Sales rose 11% to $3 billion. However, earnings fell short of Wall Street expectations by a penny, causing the stock to drop 7% and Merrill Lynch to downgrade the stock from a "Buy" to a "Neutral" rating.

And the numbers are a little deceiving; Nike got a boost from the weak dollar, which added strength to foreign sales. For instance, worldwide orders for athletic footwear and apparel rose 4.4% from a year ago, but after factoring out currency effects, sales actually fell 0.6%. Futures orders in the U.S. fell even more, by 10%. Hopefully for Nike's sake, the $90 million endorsement the firm paid to #1 NBA draft pick LeBron James will pay off in revived sneaker sales.



XIV. NO JAVA FOR MICROSOFT JUST YET
MICROSOFT (MSFT, $26, unch.) won an appeal against rival SUN MICROSYSTEMS (SUNW, $4.73, down 0.43) in a long-running case involving software conflicts. A judge had ruled that Microsoft unlawfully sabotaged Sun's Java software by not including it in its latest version of Windows. But the appeals court overturned the decision, which would have forced Microsoft to carry the software. Now, the case will go back to trial, but it likely won't restart until 2005. Sun is seeking $1 billion in damages. This is just more water under the bridge for Microsoft, which earlier this year settled antitrust cases with several states, and with AOL TIME WARNER (AOL, $15.82, unch.).



XV. UNITED AIRLINES MAKES SOME BUCKS
United Airlines parent UAL improved its financial health last month, according to its latest fiscal update. The struggling airline produced a cash flow increase of $455 million, giving the firm a total of $2.2 billion cash at month's end. The company, currently in bankruptcy protection, plans to emerge late this year or early 2004, and of that cash balance, $660 million has been marked for repayment of certain obligations. Although cash flow increased in May, UAL posted a loss of $155 million for the month. The company is doing all it can to stay afloat, and the tide is turning in its favor. But it will be a long time before this firm will be healthy enough to warrant an investment.

Good investing next week!


Todd Shaver
Editor in Chief
[e-mail]
THE BULL MARKET REPORT
United States of America
Educating investors since 1997

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1. SECTOR-RELATED NEWS

INTEREST RATES

LOWER INTEREST RATES: THE GOOD AND THE BAD

As you likely know by now, the Federal Reserve announced an interest rate cut of 25 basis points Wednesday afternoon, dropping the benchmark Fed Funds rate to 1.00%. The rate hasn't been this low since 1958. But the news received mixed reviews from the market, which turned to the downside soon after the announcement. That's because many investors hoped for a 50-bp cut to really get this economy going.

TODD'S TAKE: This marks the 13th time that the Fed has cut rates since 2001. And from the looks of it, this may not be the last time.

Although the Fed saw improvements in spending trends and financial conditions, the bank warned, "The economy, nonetheless, has yet to exhibit sustainable growth." Not exactly a glowing statement of economic strength, is it?

Furthermore, deflation remained a staunch concern, as the Fed cautioned that price declines were "likely to predominate for the foreseeable future." At the very least, interest rates will remain low for a while.

What does the lower interest rate mean for consumers? Well, rates on business and credit card loans will decline, making it easier to borrow money. But mortgage rates likely won't fall further, as they had already dropped to record lows on the expectation that the Fed would cut rates. In fact, last week 30-year fixed rates rose from record lows of 4.99% to 5.10% last week, signaling that the tide may be turning in the mortgage market.

On the downside, lower rates hurt savers by dropping yields on money-market funds and savings accounts. Money-market yields have fallen from over 6% at the beginning of 2001 to an average of just 0.64% these days. And an executive at iMoneyNet, the research firm that released those figures, said, "If anybody is still earning interest on a checking account, they probably won't be next week."

Low rates could also damage the corporate borrowing network, since the more than $1 trillion of money-market funds held by consumers largely funds the commercial paper market. If investors are reluctant to hold the funds, then companies will find it harder to take advantage of the low interest rate environment and will end up borrowing less. Less borrowing means less spending, and that's NOT what we need right now.

At any rate (no pun intended), we hope that the latest cut does what it's expected to do: Spur economic growth. The government has thrown a lot of stimulus into the economy, including the recently-approved tax cut, and much government spending. But will it pay off? Ultimately, we believe it will. But it may take a while before we reach that point.