There's a perfectly reasonable explanation why the market isn't tanking on President Donald Trump's trade war rhetoric – but that could change, said Wall Street veteran Jim Paulsen.
U.S. stocks rose Tuesday, despite new retaliatory tariffs from China. Trump announced Monday the latest American tariffs on Chinese goods.
For one, investors are getting used to the trade headlines, Paulsen said on "Power Lunch."
However, the big thing is the U.S. economy right now.
"As long as the economic data stays good, as good as it's been, the Teflon around President Trump's trade war, the Teflon around [Federal Reserve Chair Jerome] Powell's tightening, is going to remain in place. The market is going to feel impervious," the chief investment strategist at The Leuthold Group said.
If those "fantastic fundamentals" slow down, which Paulsen said he thinks will happen, then the "Teflon comes off" and the markets might start to struggle.
"There's no way the president can continue a trade war if the U.S. growth slows back into the 2s somewhere. I think he'd have to stop," he said.
Gross domestic product growth in the second quarter of this year increased at a 4.2 percent annualized rate, according to the Commerce Department's estimate.
Paulsen has been warning that stock market returns will be weak for the next few years. He said Tuesday that right now valuations are "extraordinarily high."
"You've got the Fed working hard to kill off the recovery, as well as the market, with tightening," he said. "You've got the president working to slow down global growth and Wall Street's depending on global sales to keep those steroid-induced earnings gains we've been experiencing going."
He would take risk off the table and suggests having much greater diversification away from the U.S. He advises raising some cash or buying short-term bonds, looking into a commodity exchange-traded fund and perhaps gold. He also said to buy stocks in more defensive sectors, and stay away from popular technology names.
That strategy "might hold us up if we hit an air pocket" in the market, Paulsen said.
He would become more aggressive if there was a 10 or 15 percent correction, as long as he still thought a recession was a way off.