The stock market opened the day Wednesday (6/23/10) essentially flat but was hit fairly hard soon after the opening by news of a 33% plunge in new home sales for the month of May, far worse than the 19% drop which had been expected due to the end of government home-buying tax credits.  While I wouldn’t read too much into new home statistics – they represent a much smaller part of residential real estate than do existing homes – existing home numbers show only modest improvement in recent months and were down in May.  The only bright spot is a very small (just under 3%) increase in median price from a year ago, but that feels quite fragile to me.

Following on two ugly days, yesterday particularly so, I would not be surprised to see the market fall below 10,000 on the Dow and retest a key S&P 500 support level around 1040 – and probably fail there.  (I’m not suggesting it’s going to happen today or even in the next week, but I think it will happen within a few weeks.)

I agree with those who say there is another leg down coming in the market, in housing, and in the economy, due primarily three factors, roughly in this order of importance:

1. The coming expiration of the Bush tax cuts
2. The tax hikes included in the ObamaCare legislation, particularly increases in the capital gains tax which I think will be particularly damaging to the stock market in Q3 and early Q4 this year
3. Regulatory uncertainty about whether ObamaCare can or will be defunded and then repealed
4. Regulatory uncertainty about cap-and-trade
5. Uncertainty about energy costs due to Obama’s moratorium and the broadly anti-energy position it signifies, even separate from cap-and-trade
6. Longer-term fear of huge deficits leading to even higher taxes
7. Broad concern that a Democrat government increasingly viewed as hyper-partisan and, worse, fundamentally incompetent will make other as-yet not widely discussed terrible policy decisions, and
8. A strengthening US Dollar

I think our best case for the next year is a roughly flat-line economy. It’s hard to imagine any surprises to the positive and easy, especially in such a fragile situation, to imagine negative surprises.

In general, my take is that most asset classes are overpriced, including stocks, government bonds, and commodities.  If I’m right, some coming market action could leave almost no place to hide (although it’s unlikely that bonds will do badly ad the same time that everything else does badly – I think bonds will hold up for a little while while other stuff falls, and then bonds will fall later.)

One trading note: Whenever I am having a hard time forumlating an opinion about what the market is likely to do in the short term, I ask myself “what would probably surprise the most people?"  So, if the market looks ugly and you hear everyone on TV saying it’s definitely going lower, look for a rip-your-face-off short-covering rally, squeezing out shorts and getting panicky money managers who are sitting on cash to jump back in, before heading lower again.