This market risk could prevent another monster surge and wipe out 2019's gains

Leuthold Group's Jim Paulsen is tempering his bull case for stocks.

Even though he believes the S&P 500 could rally at least another 10%, there's a catch.

Paulsen won't rule out a recession.

"Between now and the summer, we're going to decide whether the economy is going to hold together or whether we're falling off a cliff," the firm's chief investment strategist said Wednesday on CNBC's "Trading Nation." If we're not falling off a cliff, it could go quite a bit higher in the second half of the year."

According to Paulsen, the most likely scenario is the economic and earnings slowdown will elongate the recovery and bull market. He finds full-on policy support from the Federal Reserve and White House favorable for additional stock market gains.

But he's not willing to bet all his chips on it.

"Recession and bear market fears would return very, very quickly and very harshly," he said. "We have a good deal of fear. Fear of bear markets. Fear of recessions. Fear of negative yields. Fear of reverting curves. ... We're climbing a wall of worry."

Yet, the S&P 500 is up almost 23% from its December low and more than 15% this year. The index is just 2% from its all-time high.

"Ultimately, if the economy stays together, then the market is going to keep going higher. And, if it does, there's going to be a lot of portfolios that really don't buy into this rally yet that are going to find themselves underweighted," said Paulsen, who prefers to hedge U.S. risks by increasing his exposure to international markets.

Regardless of whether U.S. stocks surge past record highs or get hit with a serious pullback, he warns the rally is on borrowed time.

"We'll get back to overheat conditions and pressures," Paulsen said. "That could come as early as the end of the year or maybe sometime next year again where better news is bad news again."

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's Closing Bell (M-F, 3PM-5PM ET). In addition, he contributes to CNBC and CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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