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5 risks that could wake the hibernating bear

With the stock market hitting another record high Thursday, it begs the question: What could spark a return of the dreaded Wall Street bear — which has been in hibernation since March 2009?

Fresh highs for the benchmark Standard & Poor’s 500-stock index, which closed up nearly 6 points to a record 1992.37 Thursday, “sets up another vulnerability phase for the market,” warns Woody Dorsey, president of Market Semiotics, a firm specializing in investor psychology and behavioral finance. He argues that the market, which has been driven higher in recent years by a mountain of cash looking for higher returns in a low-yield world, or what he dubs a “liquidity gestalt,” can’t go up forever.

So what exactly can stop this rampaging bull, which has piled up paper gains of 194% since March 2009, while gorging on cheap money served up by central bankers in the U.S. and around the globe?

Here are five things that could go wrong:

1. A negative “event.” It could be as simple as a bad headline that spooks investors enough to give the bear an opening, says Bill Hornbarger, chief investment strategist at Moneta Group.

“What turns it? I believe markets will correct based on events not valuations,” says Hornbarger, adding that an energy shock related to the Middle East or interest rate hikes from the Federal Reserve could unravel markets.

2. A bad reaction to Fed rate hikes. The bigger risk is the bond market “in light of the inevitable rise in interest rates,” says Dan Veru, chief investment officer at Palisade Capital Management.

“Interest rates rising too quickly could harm the market and put pressure on stock prices,” says Veru.

Low borrowing costs, of course, have been credited for the sharp rise in stock prices in the current bull market, as investors have taken on more risk to garner fatter returns.

Fed chair Janet Yellen is slated to deliver a speech Friday in Jackson Hole, Wyoming. Wall Street will be looking for more clues as to when and how fast the Fed plans on hiking short-term interest rates next year. On Wednesday, minutes of the Fed’s July meeting were released and hinted at the Fed having to move to raise rates earlier than expected.

Short-term rates, which the Fed controls, are currently pegged at a record-low range of 0% to 0.25%. And with the Fed on track to end its market-friendly bond-buying program, dubbed QE, in October, Wall Street is trying to figure out if the first rate cut will occur in mid-to-late 2015, as expected, or perhaps earlier.

3. Irrational exuberance. The same thing that ex-Fed chief Alan Greenspan famously warned about in a December 1996 speech — so-called “irrational exuberance” — as always, is also a risk, says Todd Schoenberger, president of J. Streicher Asset Management.

If people think stocks are the only game in town as they keep hitting fresh highs, it could set the market up for a fall if a sudden downturn occurs and people get spooked and are forced to dump shares they bought with borrowed money, he warns.

“Here’s the thing that truly concerns me: risk,” says Schoenberger. “We routinely hear stories about people just jumping into the market, and that’s critically dangerous.”

4. Overvaluation. Remember early 2000, when the broad market was selling at like 30 times earnings and crashed. While this market isn’t nearly as pricey (the S&P 500 is selling at 16.7 times its estimated 2014 earnings), it is still trading a tad above its historical average. And even the Fed’s Yellen earlier this summer has said that pockets of the market are suffering from “substantially stretched” valuations.

A market that eventually gets overvalued is also a potential bull killer, adds Jim Russell, senior equity strategist at U.S. Bank Wealth Management.

“Valuation might get a bit too high,” Russell says, “and that would ‘break the back’ of the markets.”

5. A one-two punch of bad news. One risk alone might not be enough to kill the bull. But if a number of bad things happened simultaneously, the market could get hurt, adds Michael Hartnett, chief global equity strategist at Bank of America Merrill Lynch Global Research.

“It will likely take a combination of potential negatives to cause a sharp market downturn,” Hartnett says. “A major correction is unlikely until a (combination) of irrational exuberance and Fed rate hikes arrive,” he says.