What a difference a couple of months make. The fear and worry that were widespread on Wall Street two months ago have largely been dissipated, thanks to monster waves of euphoria that struck earlier this week when the Dow Jones industrials sprinted above the 14,000 mark to an all-time high. What’s more, market sentiment, extremely pessimistic in August, has now worked its way into the bullish zone.

Sounds good, but a thick dose of skepticism still abounds among a number of savvy pros. Moreover, some see danger ahead.

One, a London money manager at Raab Associates, Marcus Raab, believes the Dow, which closed yesterday at 13,974.31, could easily drop to about 12,500 before it hits the mid 14,000s. “The legitimacy of the rally we’ve had is seriously open to question and will almost certainly be short-lived,” he says. “Don’t ask me to explain why because everyone knows why.”

Mr. Raab also thinks it is likely that Santa will skip Wall Street this year.

Another worrywart is a former Merrill Lynch strategist, Bill Rhodes. “The jury is still out on liquidity problems. I worry about some quality borrower here or overseas that may have problems rolling over commercial paper, and I’m not sure consumer spending can continue at its current pace,” Mr. Rhodes, currently head of the Boston-based investment adviser Rhodes Analytics, tells me. The market, he worries, is saying it’s out of the woods and that expected third-quarter earnings problems would not spill over into the fourth quarter. “Who can say with any certainty that’s right?” he asks. “I would be extra wary of the market right now.”

The overriding view of the bulls is that the market has undergone a dramatic shift thanks to what they view as a clear decision by Ben Bernanke & Co. to embark on a new rate-reduction path, a move aimed at eliminating the possibility of a recession and easing worries about liquidity problems, the subprime crisis, a credit crunch, and the worsening housing picture. In this context, some bulls view the recent cut in the federal funds rate to 4.75% from 5.25% as a prelude to additional decreases that could knock the rate down to about 3.5%.

Nevertheless, a number of Street economists, given a softening economy and credit woes, have raised the odds of a recession, with some giving it a 50–50 possibility. The chief investment strategist of Wachovia Securities, Rod Smyth, is one of those pros who expresses concern about the higher odds of a recession, although he thinks it will be avoided, especially, he says, as he sees tentative signs that the lending freeze is starting to thaw. After saying that, though, he laces his no-recession expectation with caution, noting that it’s more difficult to see an end, yet, for the housing industry’s problems.

He also tosses into the equation a couple of economic caveats, namely the risks of a precipitous erosion of confidence in the dollar and a rise in inflation expectations to new highs. If either were to occur, he believes, the Federal Reserve’s ability to ease, even in the face of a recession, would be undermined.

Speaking of inflation, which a lot of bulls are quick to describe as low and practically a non-event, a hedge fund manager at Balestra Capital Partners, Jim Melcher, sees it picking up markedly as the Fed continues to flood the financial system and allows the dollar to fall even more. “Were setting ourselves up for a worse financial crisis later on and competitive currency devaluations around the world,” he says. To Mr. Melcher, it all adds up to “an accelerating debasement of paper currencies, a potential run on the dollar, and an absolute necessity to own gold.” As far as stocks go, cautionary flags are hoisted by a former Goldman Sachs strategist, Fred Dickson, who expects investors to “run into a wall of worry” about the magnitude of projected fourth-quarter earnings warnings. With the economy softening, “I see very few positive earnings surprises and a lot more earnings warnings,” he says. As such, he looks for the current quarter to be extremely volatile, coupled with frequent but limited dips.

Why just limited? Because, as Mr. Dickson, the chief investment strategist of a Northwestern brokerage biggie, D.A. Davidson & Co., sees it, the horde of cash on the sidelines (namely $2.8 trillion in moneymarket funds) should temper any decline. But given his earnings worries, he sees only a modest market rise of about 2% between now and year-end. Like Mr. Raab, he, too, thinks Santa may bypass Wall Street this year. Mr. Raab, despite his negative near-term outlook, still thinks certain themes are attractive, notably energy, defense, infrastructure building, and Asia. In this context, his top picks are Chevron, Northrop Grumman, Fluor, and Garmin.

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