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Bull Market Weekly Advisor:

STOCKS BOUNCE BACK IN SHORTENED WEEK

FOR THE WEEK, THE DOW JONES notched an 81-point gain, or 0.9%, to end at 9070.

THE S&P 500 rose 10 points, or 1.0%, to close at 986.

AND THE NASDAQ surged 38, or 2.3%, to finish the week at 1663.

Independence Day trimmed the trading week to three-and-a-half days, but eager investors made the best of their time. Surprise, surprise: The stock rally continued. The markets bounced back from last week's downswing, and finished the shortened session on higher ground.

Given the mix of news that came out this week it is obvious that investors are looking for reasons to buy. The news on the economic and corporate fronts was mixed, at best, but investors saw (or imagined) a silver lining and bought. The buying mood was tempered somewhat on Monday by the Chicago Purchasing Managers Factory Index, which showed miniscule growth in June but still came up short of expectations. Frankly, the news on the manufacturing front was worse on Tuesday, but it failed to deter buyers. The Institute of Supply Management report showed that manufacturing activity continued to shrink in June. Investors, however, chose to focus on the fact that new orders and production were up slightly over May.

On Wednesday investors "powered" up on May's 0.4% increase in Factory Orders and pushed the markets higher -- with the Dow hitting a triple-digit gain.

This week's economic data really are a good snapshot of this economy over the past year, at least. Add up the manufacturing results (the lifeblood of an economy) and they show an economy stuck in the sand. It is not moving. Now, throw in ongoing job cuts in sectors as diverse as Telecom and Pharmaceuticals and you see clearly that business is not ramping up -- it is still cutting costs. Thursday's jobless report confirmed it. The unemployment rate hit a nine-year high in June.

Note that throughout the week investors received some prodding by analyst upgrades (of INTEL (INTC, $22, up 1), for instance) and downgrades (BOEING (BA, $36, up 2)). In our opinion analyst ratings still carry more weight with investors than they should, especially after the dot-com stock debacles on Wall Street. Many of the ratings, like Intel for instance, are still painfully out of step with reality. And this week the economic data again proved it.

On Thursday, the market was weak, as the job market was the culprit. The Unemployment Rate jumped from 6.1% to 6.4%, a 9-year high, as 30,000 jobs were lost in June. Additionally, Jobless Claims, which had been declining of late, surged well above the 400,000 mark, wiping away all of last month's improvement.

As we noted, investors are chomping at the bit to take this market higher. Furthermore, while they are moving primarily on economic news, they seem to be growing increasingly selective about what news they deem worthy of consideration. This is dangerous in light of the fact that so many seem caught up with hopes of a "second half recovery".

For those calling for a second-half expansion, here's a news flash: We're now officially in the second half of the year. And one of the first reports to come out in the third quarter was a horrid measure of the job market, which is not only resisting improvement, but actually getting worse. Are the markets blind to this, or just willfully ignorant?

Well, if you have bought into this rally based on a strong second half, then here are some words of warning. The market usually reacts in advance of any economic changes. This current rally which has tapered off in the past few weeks, was built upon the belief in a second-half upswing in the economy. If we don't see better data over the next couple of months, then watch out below.



ECONOMY WATCH

1. OPTIMISM IN THE MANUFACTURING SECTOR
The Chicago Purchasing Managers released their latest Factory Index on Monday, reporting a second straight monthly rise. The Index ticked up to 52.5 in June, from a reading of 52.2 in May. New orders also increased, from 54.6 to 54.8. The Index remained above the key 50 mark, seen as the dividing line between a contracting and an expanding sector. However, economists expected an improvement to 52.8 in the overall Index, so the report was a bit of a disappointment and aided the market's late-day swoon. At any rate the Index suggests that manufacturing activity has improved. If the Institute for Supply Management's national Manufacturing Index is positive as expected, that builds the case even further.



2. MANUFACTURING INDEX ALMOST SHOWS WE'RE GROWING
A much-anticipated report on the Manufacturing sector was released by the Institute for Supply Management (ISM) on Tuesday, and it offered mixed messages on the economy. The ISM's June index clocked in at 49.8%, up slightly from May's 49.4% but below the 50% mark for the fourth month in a row. 50% is a key level because it marks the line between a contracting sector and an expanding one. Economists expected the index to reach that level, predicting a reading of 51.3%.

It wasn't all bad news, though. Two key index measures -- new orders and production -- expanded during the month. And at least the report does suggest a turnaround in manufacturing activity, albeit at a slower recovery than expected. This report falls right in line with our feelings on the economy. We have no doubt that it will recover sooner or later. But we're not convinced that it will bounce back in the second half of THIS year.



3. CONSTRUCTION SPENDING DECLINES
The Commerce Department on Tuesday reported an unexpected decline in Construction Spending for the month of May. Spending fell 1.7% to $870 billion, worse than the 0.3% uptick that economists expected. Additionally, figures from April were revised downward to a 0.7% drop, from a 0.3% decline. You can blame the weather for a drop in construction activity, as a soggy May curbed new home, business, and public building. Office construction was especially weak, falling a huge 24% in the month. Yet another sign that business spending has yet to return to the economy.



4. FACTORY ORDERS GAIN IN MAY
On Wednesday, the Commerce Department reported that U.S. Factory Orders rose 0.4% in May, turning around from a 3% drop in April and clocking in better than the flat results that were expected. Non-defense capital goods, however, fell for the second straight month, by 0.8%. But orders for all factory goods excluding defense products rose 0.8%. As with the Chicago PMI and the ISM Manufacturing Index earlier this week, this report tells us that the Manufacturing sector is rebounding, but at more of a snail's pace than a cheetah's.



MARKET MOVERS

I. INTEL ADDS SOME CHIPS TO THE PILE
Intel, struggling to make an impact with its new Itanium chips for the high-end computer market, unveiled the Itanium 2 chip, code-named "Madison." The chip will be used in computers that use as many as 64 processors and sell for hundreds of thousands of dollars. But the competition in the market is fierce, as many corporations have cut back on IT spending as the economy struggles to regain its footing. High-end market leaders HEWLETT-PACKARD (HPQ, $21, unch.) and INTERNATIONAL BUSINESS MACHINES (IBM, $84, up 1), as well as DELL (DELL, $32, unch.) have begun offering computers with the new Itanium 2, but SUN MICROSYSTEMS (SUNW, $4.79, up 0.06) has decided not to sell the new chip.

At least one brokerage thinks that the new chip will breathe life into the stock, which has stagnated around the $20-21 level after a strong run-up earlier this year. Also citing reachable 2Q and 3Q earnings estimates and a more favorable pricing environment, Smith Barney upgraded the stock to an "Outperform" from an "In-Line" rating and raised its price target on the stock to $23. But that's not too far away from Intel's current price. We don't think that the stock will move much further than that until business show us truly increased spending. Until then, stay away from Intel.



II. SEAGATE TECHNOLOGY RAISES EARNINGS ESTIMATES
SEAGATE TECHNOLOGY (STX, $19.50, up 1.32), a leading maker of computer hard drives, guided up its fiscal 4Q (ended June 27th) revenue and earnings projections after the bell on Friday. While revenue will be in-line to slightly above the current consensus estimate of $1.54 billion, new earnings forecasts of 30-33 cents a share are higher than Wall Street expectations of 28 cents. In addition, the company's Board of Directors approved a quarterly dividend increase, from 3 cents a share to 4 cents. It's nice to see some good news out of the Tech sector for a change. But we still believe that most Tech companies are overvalued. And Seagate's news didn't spark any major buying, as the stock fell 3% in Monday's trading.



III. GERMANY SPEEDS UP TAX CUTS
There's no question that Germany's economy has been struggling. The country is close to -- or may already be in -- its second recession in the past two years, and it is desperate to revive its stagnant economy. The government took steps to do that, accelerating a huge tax cut to receive the benefits sooner. Originally scheduled for 2005, the tax cuts will now take place next year. Overall, Germany's new cuts -- which drop the max rate from 48.5% to 42% -- will save taxpayers $20 billion. Hopefully, the new move will add life to the German economy, which is one of the world's biggest.



IV. ACCOUNTING CHANGE TO MAKE BIG WAVES
A new accounting rule took effect on Tuesday, and it will add nearly $400 billion to both the assets and liabilities of S&P 500 stocks, according to investment bank Credit Suisse First Boston. Enacted to crack down on the misuse of accounting practices -- like Enron's infamous synthetic leases and special purpose entities -- the change will make it harder for companies to conceal debt. Nearly half of S&P-listed companies will be affected by the change, which should add $380 billion in assets and $375 billion in liabilities to the books.



CITIGROUP (C, $44, up 1) will likely record the biggest benefit, adding $55 billion in assets due to the rule. GENERAL ELECTRIC (GE, $29, unch.) should add $45 billion. BANK ONE (ONE, $37, down 1) and WACHOVIA (WB, $41, up 1), meanwhile, should add about $10 billion in assets with the change. But watch out for companies that surprise investors with increased debt due to the change. That may take some of the air out of the 2Q earnings sail later this month.



V. FLYING THE FRIENDLY SKIES: AIRTRAN CHOOSES BOEING OVER AIRBUS Aerospace firm Boeing received a huge order from discount airline AIRTRAN AIRWAYS (AAI, $11.40, up 0.99) for as many as 114 new planes. AirTran chose Boeing over British rival Airbus for its order of 50 new 737 planes, with options for 50 more and up to 14 717s. The deal will be worth over $6 billion if all options are exercised. This is a big win for Boeing, as competition for new orders in the struggling Airline industry has been fierce. Airbus had won orders from JETBLUE AIRWAYS (JBLU, $43, up 1) and big British discount carrier EasyJet. But all was not rosy for Boeing, as Deutsche Bank downgraded the stock to a "Sell" from a "Hold" rating on the belief that weak fundamentals in the Aerospace sector don't warrant a rise in the stock.

This is also good news for General Electric. The conglomerate's GE Capital Aviation Services unit will finance delivery, set to commence next year, of at least part of the transaction. And GE gets a double boost from the announcement. Another business unit -- CFM International, jointly owned with the French government -- is the primary supplier of 737 engines.



VI. VERIZON TAKES HUGE CHARGE
VERIZON COMMUNICATIONS (VZ, $40, unch.) will take a staggering $3 billion in charges related to accounting changes in its telephone directory division and a planned sale of its Mexican wireless unit. Instead of recording revenue and earnings from directories upon release, the firm will distribute results throughout the life of the book, which usually lasts 12 months. That stabilize earnings throughout the year. But the huge charges, which amount to $1.6 billion after taxes, will be recorded as one-time items. The firm left its earnings outlook unchanged at about $2.75 a share. Because of that, investors largely ignored the news, and shares of the company ended virtually unchanged.



VII. LAYOFFS IN THE DRUG AND WIRELESS SECTORS
BAXTER INTERNATIONAL (BAX, $25, unch.) announced 2,500 layoffs and lowered its earnings outlook for the third time in four months. The company's blood therapy business has faced stiff competition, so it will close 26 plasma collection plants and one manufacturing facility. The job cuts, which amount to 5% of the company's total work force, will result in a 2Q charge of $200 million, or 30 cents a share. That will drop earnings to 11 cents for the quarter and to $1.70 for the full year. Even excluding the charge, earnings will come in below previous estimates, at $2.00 a share vs. the $2.15 estimate. The stock fell 2% on the news.

In other job cut news, AT&T WIRELESS (AWE, $8.22, down 0.17) will lay off 1,000 employees, or 3% of the company's total labor force. That follows 2,000 cuts last year. The firm enacted the layoffs in order to improve efficiency and generate "industry-leading margins." These new announcements certainly won't help the job market recover.



VIII. AND MORE LAYOFFS IN THE AIRLINE INDUSTRY
AMR'S (AMR, $10.13, down 1.19) American Airlines will lay off 3,100 flight attendants and possibly cut more flights, the company announced Tuesday afternoon. The world's largest airline hopes that the cost-cutting moves will save the firm $4 billion annually. In addition, American will close one or more maintenance facilities and ground 57 planes -- following the 57-plane cut in its fleet last year. The Airline sector is in a deep recession, and consumers continue to stay away from air travel. American and United Airlines needed to cut away their excess fat, and now they are doing so. But it will take a long time before they become profitable. And not all of them may be around to ring in the occasion.



IX. UPSIDE SURPRISE FROM PEOPLESOFT FAILS TO IGNITE SHARES
PeopleSoft, still mired with merger concerns, assured its investors that the problems did not affect the firm's business during the quarter. The Business Software firm raised its sales guidance for the second quarter, from $455 million to $495 million. Analysts had expected the firm to report only $445 million in sales. Higher sales will lead to higher earnings as well, of 10-11 cents a share vs. previous forecasts of 8-9 cents. But the stock slipped a bit in Wednesday's trading. That's because a stronger performance from PeopleSoft makes it harder for ORACLE (ORCL, $12.15, down 0.28) to acquire the firm. Oracle, if successful with its hostile bid, plans to shift existing PeopleSoft customers to its own software. Investors had pushed PeopleSoft shares towards Oracle's bid price in the event of a takeover, so it makes sense that PeopleSoft stock slipped a bit on the news.

Good investing next week!


Todd Shaver
Editor in Chief
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THE BULL MARKET REPORT
United States of America
Educating investors since 1997

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1. SECTOR-RELATED NEWS

FINANCIAL

FREDDIE MAC: A BARGAIN, OR JUST CHEAP?

TODD'S TAKE: "If FREDDIE MAC'S (FRE, $53.50, up 3.50) stock were a house, it would be the ultimate 'fixer-upper': On the surface it is a bargain, but unseen problems could make it a money pit."

That's how the "Heard on the Street" column in today's Wall Street Journal starts off. There's no question that the stock is cheap. Freddie's PE of 6 is the second-lowest valuation in the S&P 500. And remember that the company is set to restate earnings higher, which will make it look even cheaper.

But it's the restatement, along with other accounting issues, that keeps many investors from calling Freddie Mac a bargain. Maybe Freddie's stock is done falling. But what can make it move higher with the cloud of accounting issues looming above?

The situation is way too muddled to figure out. In fact, Freddie itself is having difficulty deciding what its fair value is, as a spokesman said, "It's tough to value us, to quantify this, given at the moment we don't have audited financial statements."

Here is what we know so far about the situation. The company has had some accounting problems. While some analysts attribute them to the complicated derivatives contracts that Freddie uses to hedge against interest-rate risk, others believe they actually involve your regular old garden-variety transactions -- maybe up to 100,000 of them. If that's the case, then the $1.5-4.5 billion earnings restatement estimated by the company could be even bigger. Freddie assured investors that these issues will be cleared up by September, but that may not hold true if further transgressions are uncovered.

The other major investor worry is how Freddie's future earnings will change. Many investors were drawn to the stock because of its solid, stable earnings growth and minimal volatility. But now that Freddie has changed its accounting methods, traipsing through quarterly earnings could be like riding a rollercoaster. The company itself says that profits will have "significant volatility." And we still don't know how the firm will restate earnings. Will the bulk of added profits come on next year's balance sheet, or will they be spread out over time?

And if investigators do uncover a scandal, then it could get ugly. That's why we're tightening our Price Alert and tempering our Target on the stock. We made our expectations more realistic, lowering our Target from $75 to $63. Freddie is right around our former Alert of $53 and has fallen as low as $47 recently. But if the stock hits $50 again, we'll be forced to remove it from our Financial Portfolio. We still believe that Freddie is a great company, and if this scandal blows over without much damage, then we're holding this stock for the long term. But we don't want to ride this one down to $40.



SOFTWARE

SHAREHOLDERS CALLING FOR A MICROSOFT DIVIDEND HAVE A GOOD CASE

Merrill Lynch offered upbeat comments on Software giant MICROSOFT (MSFT, $26, up 1), upgrading the stock and adding it to its Focus 1 list. The investment bank raised its rating to "Buy" from "Neutral," and the stock rose 3%. Merrill cited the chance for a dividend increase as one reason for the upgrade.

TODD'S TAKE: Microsoft, the world's largest software company, has long heard investor demands for a dividend. After all, the firm has more than $45 billion in cash and is set this year to produce about $13 billion in cash flow. Earlier in 2003 the company initiated an annual dividend of 8 cents a share -- which in the scheme of things seemed mostly symbolic -- arguing that its ongoing legal battles preclude the firm from issuing a larger dividend. But with its legal problems disappearing, and costs barely scratching the surface of the firm's massive cash holding, Microsoft is finding arguments against a dividend disappearing. The shareholders' argument, meanwhile, seems to be making more and more sense: Simply put, they're not getting their money's worth.

According to Barron's, if Microsoft does nothing over the next five years, its cash holdings will hit $100 billion! That's if it does nothing. Zero. That is unbelievable.

Right now, Microsoft has $46 billion in cash and another $13 billion in investments. There is no point to having this -- and the money is no benefit to shareholders -- unless the company uses it for SOMETHING. So what are the firm's options?

Microsoft could make a large acquisition. That's unlikely, however, because antitrust matters would likely bar the firm from buying a dominant position in another software market.

The company could buy back stock. That's a popular option among shareholders -- especially recently. They've watched Microsoft's stock remain stuck in neutral while the rest of the Tech sector has stormed higher. Gates & Co., however, have maintained that some of its shareholders hold the notion that the company has overpaid for its own shares in the past. So, Microsoft remains cautious on this front.

Option #3: The company could issue a dividend. In fact, an annual dividend of 50 cents a share (which would give the stock a yield of 2%) would cost the firm about $6 billion a year. That would leave it plenty of room to continue buying back stock, to fund its hefty R&D budget, and make any acquisitions that it wants. Most importantly from a shareholder's perspective, a sizable dividend would let shareholders reap some rewards for holding Microsoft stock -- and push shares higher in the process.

Microsoft obviously can't hold onto this much money forever, so it isn't really a question of IF shareholders will benefit from the growing sum. Rather, the question is WHEN they will benefit. The company has moved at a crawl when it comes to making a decision about using its cash, and unfortunately for Microsoft shareholders, the firm doesn't feel any pressure from its Tech brethren, who -- with the exception of HEWLETT PACKARD (HPQ, $21, unch.) -- don't pay dividends either.

Still, we believe that time is on the shareholders' side. If Tech stocks come back down to earth this summer after a dizzying rally (which we suspect they will), then Microsoft will have to do something to distinguish itself and justify its forward PE of 25. A healthy dividend would do the trick just fine.



AUTOS

U.S. AUTOMAKERS CONTINUE TO STRUGGLE

The June auto sales figures for the Big Three U.S. automakers were released Tuesday, reflecting a slight improvement in the sector. #1 automaker GENERAL MOTORS (GM, $36, unch.) announced a sales increase of 1.5%, as a 9% decline in car sales was offset by a 10% jump in light truck sales. In fact, sales of light trucks, which include sport utility vehicles, set an industry record for the third straight month, at over 247,000.

DAIMLERCHRYSLER'S (DCX, $36, up 2) Chrysler Group posted a strong 6% sales increase, largely due to strength in its new Pacifica crossover SUV. But FORD MOTOR (F, $10.87, down 0.16) reported a 1% decline, as cars sales fell 8% and light truck sales rose less than 3%. Overall auto sales rose 4% to an annualized rate of 16.4 million vehicles.

TODD'S TAKE: This is the same story we've heard for the past few months. Even though the automakers have continued with huge price incentives and promotions, sales are little improved.

And these companies sure are spending. GM led the industry with incentive spending of $3,800/vehicle, as the company extended its 0% financing and $3,000 rebate programs. Ford and Chrysler were also big spenders, at $3,600 and $3,400, respectively.

But has the extra spending paid off? Not in terms of capturing market share from foreign firms -- or even holding onto it. TOYOTA MOTOR (TM, $54, up 2) reported record sales that rose 11%. HONDA MOTOR (HMC, $19.90, up 1.00) reported 9% sales growth, while sales at NISSAN MOTOR (NSANY, $20, up 1) surged 22%. Since foreign sales were so much stronger than domestic sales, it makes sense that the Big Three lost market share to their international rivals, from 62% of the North American market to 60.6%.

And the Japanese automakers are doing it largely without incentives. Toyota paid an average of just $1,200/vehicle, while Honda spent a mere $500.

On a brighter note for the domestic Auto sector, many firms see a buyer shift towards more expensive luxury and sport utility vehicles. According to GM, nearly one-third of all U.S. auto sales were priced above $30,000.

But that will be little comfort for U.S. firms if the Japanese companies once again take that business away. They have already attacked the all-important light truck category. And the last bastion of American auto dominance -- full-size pickup trucks -- has been invaded by Nissan, which is set to introduce the Titan later this year.

These concerns didn't stop GM and Ford from predicting a second-half improvement in auto sales. If lower interest rates truly spur economic growth, then that may be a reality. But from the looks of it, the Japanese firms, not the Big Three, will be the ones to benefit.