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@theMarket: Fly Me To The Moon

By Bill Schmick
iBerkshires Columnist
Good news is good news but bad news is even better news for the stock markets. If you doubt that, just look at recent events and how investors have reacted.

"I don't get it," said a reader on Friday morning. He was sure that the markets would crater on the back of a disappointing Gross Domestic Product number for America's first quarter. The data indicated our economy slowed from last quarter's 3 percent growth rate to 2.2 percent.

"Not only was the U.S. market up, but so was the Spanish market. That doesn't make any sense. Will you help me out here?" he asked

It is true that S&P, the credit agency, downgraded Spanish sovereign debt Thursday night by two notches from A to BBB-plus. S&P believes that Spain’s budget deficit is going to worsen based on further declines in their economy. In a different era our reader would have been correct in anticipating a downdraft in Spain’s stock market, but not in this environment.

Investors took the initial decline in their stock market as another buying opportunity. By the time the U.S. opened on Friday the Spanish market was up by almost one percent. So what makes weak economic data, whether in the U.S. or Spain such an opportunity for investors?

Investors are conditioned to believe (after two and a half quantitative easings here at home and the on-going monetary stimulus in Europe) that the weaker the data becomes the higher the probability that the governments will step in and save us. Thus, the worse the news becomes, the better it is for the future of the stock market. There is plenty of precedent to believe that.

Just look back at what has happened every time our government-influenced stop and start economy began to slow over the past few years. The cycle began with the first stimulus package combined with central bank monetary stimulus (QE I). For a short time the stock markets skyrocketed, the economy grew and unemployment began to decline. But as QE 1 waned so did the economy, and with it the stock market.

The Fed waited and hoped the slowdown was simply a blip but in the end the negative data forced the Fed to launch another program (QE II). Once again the economy and the markets reacted by moving higher. But here we are again. The economy is slowing and investors are expecting the Fed to bring a new punch bowl to the party.

Will the Fed cooperate? Yes, at some point if necessary. QE III is not on the table quite yet and may never be if the economy can find legs of its own. But if the economy and unemployment begin to slow further then we can expect another save by the Fed. Of course, the devil is in the details. The key words to focus on are "if" and "further." Those words appear to represent one thing to the Fed and another to investors.

At this point, no one (including the Fed) really knows if the country is in a sustainable recovery.  Investors who expect the Fed to launch QE III because the economy declined .80 basis points in one quarter are smoking something. In each of the prior cases of Fed easing the stock markets and the economy had to stall dramatically before the next round was launched.

You might recall that in each case we had to suffer an 18-23% stock market decline before the Fed stepped in to save us. If those same investors expect the Fed to ease with the stock markets approaching the year’s highs then once again, give me some of what you’re smoking.

Yet, in my opinion, that's what the markets are betting on. If we look back at the month to date, we could argue that the markets gave us the 5 percent correction we had been looking for and are now poised to move higher. A contrarian indicator like bearish market sentiment is rising. Dips are being purchased once again and momentum seems to be on the side of the bulls for now.

I'm thinking we could run another couple of percent here on the S&P 500 Index, at least to 1,420 or maybe as high as 1,450 over the next few days or weeks. If you are nimble, you might be able to take advantage of that move. If, on the other hand, in-and-out trading is not your style than just stay where you are and enjoy the fireworks.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or email him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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The Independent Investor: Not In My Back Yard

By Bill Schmick
iBerkshires Columnist
Part II in a look at the boom in natural gas; Part I can be found here.

The oil and gas boom in this country has had some serious side effects. Everything from earthquakes to polluted water has been blamed on the industry. Residents near the areas of hydraulic drilling and exploration are fighting back using the Environmental Protection Agency, lawsuits, lobbying and the media. The challenge is separating fact from fiction in this on-going fight.

There is no question that there has been a remarkable increase in the number of earthquakes in the middle of the country, for example, or that an entire neighborhood of homes in Dimock, Pa., claimed it was threatened with explosive levels of methane gas. Twenty water wells in the same area, the site of natural gas drilling in the Marcellus Shale, showed the presence of sodium, methane, chromium or bacteria.

A recent documentary, "Gasland," on HBO featured another Pennsylvania village caught in the controversy over America's oil and natural gas boom. The movie allegedly uncovered the "secrets, lies and contamination" of natural gas drilling. As a result of the growing controversy three states — New Jersey, New York and Pennsylvania — have called a moratorium on any further drilling or hydraulic fracturing for the time being. That is a big deal because the Marcellus Shale sits below those states and has enough natural gas to fuel this country for the next 20 years.

Environmentalists and people living near drilling sites are saying not in my back yard. They believe that attitude is justified since the risks are great and who can blame them? I'm sure I would feel the same way if someone proposed to drill a well in the parking lot of my condo. The moratorium is needed, so its advocates argue, simply to study the impact of this drilling before people get hurt or sick. Naturally, the energy industry is arguing that the risks are small and that thousands upon thousands of wells have been drilled with no negative impact whatsoever. They have a point.

Take the earthquake issue, where a study by the U.S. Geological Survey identified a sixfold increase in manmade quakes in an area including Arkansas, Colorado, Oklahoma, New Mexico and Texas. All the headlines pointed to natural gas drilling as the culprit. The gas guys were found guilty, strung up and buried before the survey team could come to a conclusion. Only then did the scientists admit that the quakes were not directly caused by hydraulic fracturing with one exception, one lone well in Arkansas.

The 20 "contaminated" wells in Pennsylvania I mentioned were later found by the EPA to present no threat to human health and the environment. As for the earth beneath the affected homes in Dimock, it did contain methane among other elements, but the EPA could not prove a connection between the contaminants and the oil and gas developments. In fact, they concluded that the presence of these elements could just as easily have been caused by naturally-occurring background levels or other unrelated activities.

I have learned that most studies tend to reflect the bias of those conducting them. In other words, you can make a study say anything you want given enough samples. This battle, in my opinion, has already been won by the weight of public opinion. A cessation of exploration will have a negative impact on the economies of all three states. At the same time, the declining price of gas will not justify continued drilling in a land of litigation.

Free market capitalists might moan and argue that a person has the right to do whatever he wants with his property including fracking. On the other side, advocates will contend (rightfully so) that there is no such thing as zero-impact drilling. One's decision to allow fracking in your backyard can and does directly impact my property next door.

The industry heightens the paranoia surrounding it by refusing  to disclose what potentially toxic chemicals (if any) are used in the drilling process. The regulations do not require disclosure so they won't provide it. They are also exempt from EPA regulation thanks to the Bush Administration's 2005 loophole legislation dubbed the "Halliburton Loophole" by opponents.

As a result, all sorts of fears can be invoked (real or imagined) by any blogger or tree-hugging anarchist that wants to invent their own bizarre plot against humanity. Is the nation's watershed in jeopardy of contamination? Many environmentalists claim it could be impacting millions of unsuspecting Americans. Without the data, we don't know. Others worry that in the vacuum caused by the absence of federal regulation, undermanned and revenue starved state regulators are turning a blind eye to industry regulation.

Back in the day, when the United States was still a powerhouse of industry, a growing and vocal group of concerned citizens began uncovering the seamier side of this formidable industrial base. We discovered that the byproducts of these industries were causing enormous amounts of air and groundwater pollution. At the same time, workers were coming down with all sorts of ailments from asbestos poisoning to cancer. Instead of helping the industrial sector transform itself into something more acceptable, we drove it away.

Politicians swooped in to pass bill after bill creating new safety standards, stricter codes and of course higher taxes on these bad boy industries. Industrial companies found themselves spending more time and money defending their practices from lawsuits, sit-ins and protests. In the end it wasn't worth it. They started looking for less hostile manufacturing locations abroad and found them.

Americans today lament the loss of that U.S. industrial base. We conveniently forget that part of the reason for that exodus was caused by a sea change in how we viewed those industries. Although the present challenges facing further gas drilling in our country should be taken seriously, let's try not to apply the same "not in my back yard" attitude toward gas drilling that sent our industrial base packing in the past.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or email him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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The Independent Investor: The Gas Rush

By Bill Schmick
iBerkshires Columnist
There is talk that this country could be the Saudi Arabia of natural gas. It's clean burning, domestically produced, abundant and offers a concrete exit plan away from this nation's foreign energy dependence. Yet, from Texas to New York, Americans appear to be willing to take up arms against any additional gas drilling.

As recently as five years ago in the U.S., natural gas was in short supply using traditional exploration and drilling methods. Then, engineers had a breakthrough. Two key technologies were discovered — horizontal drilling and hydraulic fracturing (fracking) — were discovered. Horizontal drilling allows gas developers to drill vertical wells that turn and snake more than a mile sideways under the ground. Fracking, which was actually invented more than 60 years ago, involves pumping millions of gallons of chemically-treated water into deep shale formations at enormous pressure. The fluid cracks or widens existing cracks in the shale freeing hydrocarbons to flow toward the well.

As a result of these technologies, vast caches of natural gas trapped in deeply buried rock have been made accessible leading to an eightfold increase in shale gas production. One of these deposits, the Marcellus Shale sprawls beneath West Virginia, Pennsylvania and New York. This deposit alone could produce enough energy to fuel every natural gas fueled device in the nation for the next 20 years.

Natural gas prices have plummeted as a result of all this new supply and are now trading at 10-year lows ($1.94 per 1,000 cubic feet). The prognosis by experts is that prices aren't going to rise anytime soon since there is so much gas still in the ground that the energy industry, policy makers, economists and natural gas customers can't figure out what to do with it.

It has already been a great boom to both residential and commercial users of the fuel. The typical consumers spent $868 on average this winter, a 17 percent decline from last year. Utilities that generate electric power consume 34 percent of the nation's natural gas output. Decline in gas prices are being passed through to customers, who are beginning to see their utility bills decline throughout the Northeast.

Another 30 percent of natural gas is consumed by industries to heat boilers or make chemicals, fertilizers and plastics. Prices have come down and supplies have reached a level that major corporations are announcing large-scale expansion projects close to the sources of these new natural gas discoveries.

Dow Chemical has announced plans to build a multibillion-dollar plant to convert natural gas into the building blocks of plastic in Freeport, Texas. Royal Dutch Shell is building a similar $2 billion chemicals plant near Pittsburg, Pa., close to the output from the Marcellus Shale. These are but two of 30 chemical plant projects that are ear-marked for the U.S. over the next five years.

Steel and iron producers are also excited at the prospect of saving over $11 billion annually through 2025. Steel maker Nucor is switching from coking coal to natural gas production of their iron products in a new $750 million plant in Louisiana. The trucking industry that now consumes just 0.1 percent of natural gas production is looking at a crash program to build natural gas refueling stations along America's Interstate Highway System to refuel new long-haul trucks that will burn natural gas.

All of this expansion means jobs. Economists predict as many as 500,000 new jobs by 2025. At the same time, if we can build the infrastructure to transport and convert our nation's existing oil-based economy to consuming natural gas over the long run, we no longer need fear turmoil in the Middle East. The whims of OPEC will be a thing of the past. At the very least, America could join the league of energy producers/exporters and begin to export our surplus gas to foreign buyers. Europe, for example, pays 75 percent more for their natural gas than we do.

All of this sounds wonderful, yet there is a darker side to this "Gas Rush." Homeowners across the nation in those regions where natural gas is being exploited have witnessed their once-pristine communities become industrial sites. In place of their willow trees or pastures, sprawling plants lit by huge flares late into the night blotting out the moon and stars.

Trucks rumble through neighborhoods spewing noxious fumes that mingle with other possibly toxic substances.  Neighbors keep children and pets behind fences away from containment ponds filled with unknown chemicals. They worry about the drinking water and hold their breath as earthquakes make the windows and china tremble where no such quakes had occurred before.

In our next column, we will examine the darker lining within this pink cloud of natural gas abundance. Opponents of fracking argue that the risks outweigh the rewards in any further development of natural gas. Here we are on the verge of a possible renaissance in American manufacturing and yet New York, New Jersey and an increasing number of municipalities and local governments are ordering a halt to further development.

Is that wise or is America once again shooting itself in the foot? What do you say?

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or email him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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@theMarket: Expect More Volatility Ahead

By Bill Schmick
iBerkshires Columnist
As we enter the second quarter, this first week is a taste of things to come. After months of enjoying a straight-up stock market, we are getting back to the new normal, so strap on your seat belts.

Monday and Tuesday were downright ugly. The next two days we climbed back up and then on Friday gave some back. It was a roller coaster and is reminiscent of the period from May through October of last year. Imagine that.

It was a down week, despite a surprise upside earnings surprise from Alcoa, which is usually the first company to report each quarter. Further good news from some big banks failed to inspire the market, however. Once again, as I wrote last week, the rain in Spain has flooded our plain.

Spanish banks borrowed twice as much from the European Central Bank in March as they did in February amounting to $419 billion. The ever-present angst among European investors has focused on Spain this month. Next month (or week) it could be Italy, Portugal or that popular whipping boy, Greece, that's back in the news.

Underlying the recent climb in Spanish sovereign bond yields is a brewing housing crisis and a faltering economy. Spanish banks are also bleeding. They are grabbling with 300 billion euros in property loans and the Spanish government has said it isn't prepared to inject any more capital into the sector. It's the same old song that will most likely end in another bailout for Spain.

I shouldn't blame Spain for all our worries. China's slowdown has also contributed to investors' worry. The annual rate for Chinese GDP growth slowed in the first quarter to 8.1 percent from 8.9 percent. I wish our growth could be even half that rate but everything is relative. And relative, in the context of Chinese economics, equates to slower growth, slower demand for materials and commodities, and a host of other goodies that the world depends on to drive their own economies. A hard landing in China coupled with a recession in Europe would not be an auspicious development for world economic growth. Right now the state of China’s economy is muddy at best.

As for our markets, the decline I have expected has begun. Pullbacks vary. If we take a look at the last nine times the markets have declined going back to mid-2010, we see that the longest correction was 22 days. The average was 15 days. Snap-back rallies can last from two days to seven days. This week's snap-back lasted two days.

What is clear is that volatility increases substantially during times like these. My advice: do not try to trade the ups and downs. You will be left with a big hole in your portfolio and end up losing far more than the market corrects. If you had decided prior to this pullback that you were going to stick with the markets, then do so, take your lumps and look to the long term.

If you followed my advice and raised cash, it is time to be patient, watch the markets gyrate but don’t let that cash burn a hole in your pocket. Patience in this kind of environment is worth its weight in gold.
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The Independent Investor: A Stop & Start Economy

By Bill Schmick
iBerkshires Columnist
Recently, worries have surfaced over the sustainability of economic growth in this country. Over the last several months, the data has been pretty good. Now the numbers indicate the economy is faltering — again.

I say again because the same thing happened last year at around the same time. Economists call that a stop and start economy, something we haven't seen since 1967. The mild winter and warmer early spring in two-thirds of the country this year has also added some confusion to the economic picture. Confusion in terms of how much of the strength in America's fourth quarter of 2011 and into the first quarter of 2012 was because of the abnormally mild weather?

On the surface, everything was looking just ducky at the start of this year. The manufacturing cycle seemed to be catching fire. There appeared to be pent-up demand, coupled with massive liquidity injections by our Federal Reserve (QE 2.5) and the European Central Bank's money giveaway as part of their bail out of Europe's financial system. As a result, economic activity exploded at the end of last year (as did the stock market).
And then came the Ides of March.

Most of the manufacturing data for March indicates a less-sanguine portrait of America's economic health.  Industrial reports ranging from the Chicago Fed's national activity index, the ISM Composite Index, and the Richmond, Dallas and Kansas Manufacturing indexes released monthly by the Federal Reserve all say the same thing. 

The economy is slowing for the second time in 12 months.

Just recently the Economic Output Composite Index marked its first decline in March since August 2011 and this week's National Federation of Independent Business (NFIB) Index confirmed that March was a real stinker.

The NFIB Index is important because it gives us a better view of what is going among small businesses, which are the backbone of our country. Over the last 6 months, the NFIB Index has grown steadily, like the rest of the economic data. But In March, nine of the NFIB's 10 index components hit the wall, declining markedly with the largest drops in hiring plans and expected real sales growth.

The gloomy prognosis for sales and hiring is especially important because small businesses hire the majority of workers in America. They are also completely dependent upon the consumer. Between fuel savings from the mild winter and lower gas prices at the pump last summer, those windfall savings generated $30 billion for American consumers. That was money they could and obviously did spend on other things. Now that the weather cycle has returned to more normal temperatures the impact of those economic "tax credits" have dissipated.

The stop-and-start performance of the economy should come as no surprise to readers. After all, it is something we have been living with since the end of the recession back in 2009. Back then, in order to "jump start" the economy, the federal government, along with our Federal Reserve, has thrown money at the problem again and again. The resultant record deficits we now endure have put an end to the government's giveaway programs but not those of our central bank.

We have printed and then poured trillions upon trillions of dollars into the economy. After each spending splurge, we have seen a rise in economic activity but as the next round of quantitative easing ran its course, that activity began to sputter once again. This bout of stimulus is scheduled to end in June. Last year we witnessed a similar phenomenon at the end of QE II.

The government and the Fed have hoped that at some point once enough money is in the system that "organic" (real) economic activity will pick up where their stimulus left off. So far that has not been the case. Given that it an election year, I doubt that the Fed or the government will allow the unemployment rate to rise or the economy to slow once again. If the numbers continue to decline we can expect yet another round of stimulus, regardless of its impact.

Bottom line: What do you call someone who does the same thing over and over again and still expects a different outcome?

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or email him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

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