DIRTY DOZEN: Things That Could Upset the Apple Cart

1. Wildly bullish sentiment readings. The latest Investors Intelligence survey is now up to 53.3% for the bulls (versus 51.1% the prior reporting week) while the bear camp has dwindled further, to 17.4% (versus 18.9% a week ago). Bullish sentiment rose for the third consecutive week and bearish sentiment has not been this low since January 12. As Bob Farrell’s Rule number 9 stipulates, when all the forecasts and experts agree, something else is bound to happen.

2. Uncertainty over the coming U.S. midterm elections in November.

3. A more hawkish Fed (futures pricing in 40% odds of a rate hike by the November meeting).

4. Tougher profit comparisons in coming quarters.

5. The fading of the fiscal and monetary stimulus. The tax credits expire on Friday, the Fed has already stopped buying mortgage bonds and the pace of new trial modifications under the Treasury’s Home Affordable Modification Program has begun to slow.

6. Fresh uncertainty surrounding banking industry regulation. Goldman is likely the thin edge of the wedge. A proposal is gaining ground on Capitol Hill to force banks to spin off their derivatives-trading operations, which would represent a severe blow to one of Wall Street’s most profitable businesses.

7. Higher tax rates to pay for the massive $1.4 trillion federal budget deficit. The Bush cuts that lowered taxes on high-wage earners and capital gains and dividends are set to expire at the end of 2010. The top marginal tax rate will jump to 39.6% from 35.0%, and the current 15% rate on capital gains and dividends will go back to 20.0% and 39.6%, respectively,

8. Huge overhang of unsold houses. As of March, banks and investment trusts had an inventory of about 1.1 million foreclosed homes, up 20% from a year earlier, according to estimates from LPS Applied Analytics. Another 4.8 million mortgage holders were at least 60 days behind on their payments or in the foreclosure process, meaning their homes were well on their way to the inventory pile. That “shadow inventory” was up 30% from a year earlier.

9. Sovereign debt problems in Greece and spillover to Portugal and possibly Spain.

10. Ongoing commercial real estate, which have resulted in 55 bank failures this year.

11. Underfunded state pension plans.

12. A property bubble in China — the government is now considering introducing new or higher taxes on real estate, possibly a property tax, in order to cool down a booming property market now widely being described as a bubble (prices up well over 10% from a year ago).

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