By Akane Otani 

Stocks are a few percentage points away from records. Data are pointing to a slowdown in the U.S. economy.

The dueling narratives are challenging investors, who say they are finding it increasingly difficult to reconcile the sustained rise in share prices with widening cracks in the U.S. economy. Many are also worried that the back-and-forth between President Trump and China, as well as the Federal Reserve, is heightening the pressure on an economy that they fear is starting to falter.

Among the warning signs: A key measure of manufacturing activity fell last week to its lowest level in a decade. Consumer confidence slipped to a seven-month low earlier in August, while expectations for corporate profits have fallen so much that analysts say earnings are likely to contract for at least three consecutive quarters in 2019.

Other parts of the economy have shown resilience despite worries that the U.S.-China trade conflict will hamper growth. Employers continue to hire at a healthy clip, and many analysts believe that if a recession were to occur, it would happen in 2020, not this year. Nevertheless, with U.S. indexes already above levels where many analysts had expected them to end the year, some investors fear the market's decadelong rally looks more vulnerable now than it has in quite some time.

That dynamic was especially evident Friday. Stocks slipped after China said it would retaliate against planned U.S. tariffs, briefly pared declines after Fed Chairman Jerome Powell made remarks on monetary policy, and then slumped after Mr. Trump delivered a series of tweets lambasting both Mr. Powell and China. Despite the swings, the market has hung on to hefty gains for the year: the S&P 500 remains up 14% in 2019 and is just 5.9% off its all-time high.

Investors will get another look at the state of the economy in the days ahead when the Commerce Department releases a second estimate of second-quarter gross domestic product and fresh data on consumer spending.

"We're starting to see some fissures," said Jack Ablin, chief investment officer of Cresset Capital.

Mr. Ablin said his firm held a call to reassure clients in mid-August when the yield curve inverted, sending the yield on the two-year Treasury note above that of the 10-year Treasury for the first time since 2007. Cresset, like many other investment managers, has trimmed some of its holdings of riskier assets such as global stocks while shifting more money into areas it believes can still offer growth, including the private equity secondary market.

Those moves aren't driven by a belief that a recession is imminent in the U.S. Instead, they reflect waning expectations for the type of economic growth that powered double-digit returns earlier in the bull market, Mr. Ablin said.

"There's a growing sense that the ability of central banks to actually turn things around is limited," he added. Mr. Powell suggested as much in remarks prepared for delivery in Jackson Hole, Wyo., on Friday, saying there were "no recent precedents to guide any policy response to the current situation."

Even as the Fed paused its rate-increase campaign and in July lowered its benchmark short-term rate for the first time since 2008, the U.S. manufacturing sector in particular has shown unmistakable signs of weakening. That has investors wondering how much more stock prices, which typically rise when investors expect growth in the future, can advance.

On the one hand, the services sector has continued to show signs of strength. Commerce Department data earlier in the month showed retail sales rose a seasonally adjusted 0.7% in July from the prior month, marking the strongest reading since March. Companies from Target Corp. to Walmart Inc. to Lowe's Cos. have posted strong earnings in the past few weeks.

Those signs are reassuring to investors, especially because consumer spending accounts for about two-thirds of U.S. economic growth.

Still, manufacturing downturns have often preceded broader economic slumps over the past 25 years, according to Capital Economics. That means it may be too early to conclude that the problems weighing on industrial companies are isolated issues.

"If we continue to see concerns about tariffs affect the way companies are investing or hiring or increasing wages...that's the real concern," said Shannon Saccocia, chief investment officer of Boston Private.

She added that, at the moment, the stock market looks relatively attractive in part because of the comparatively paltry returns that government bonds around the world are offering.

But as earnings decline further, stocks will look "more and more expensive, so there's a concern there," Ms. Saccocia said.

Some investors are holding out hope that, with the U.S. presidential elections approaching in little more than a year, Washington and Beijing will come to a truce that helps stabilize weaker sectors of the economy.

"The only thing I look at that I worry about is earnings and manufacturing, both of which I attribute to tariffs and overseas trade," said Tom Stringfellow, president and chief investment officer of Frost Investment Advisors.

For Mr. Stringfellow, the economic data don't look worrying enough yet to warrant a major rethinking of portfolios. Though the labor market's expansion has slowed this year, the economy has nevertheless extended a record 106-month streak of job creation. And the unemployment rate continues to hover near a multidecade low.

What gives Mr. Stringfellow pause: Much of the returns of the first half of the year appear to have been driven by central banks' shift toward lowering interest rates, he said.

For markets to churn higher from here, "We have to see the economy growing," he said. "It can't just be central bank policy."

Write to Akane Otani at akane.otani@wsj.com

(END) Dow Jones Newswires

August 25, 2019 08:14 ET (12:14 GMT)

Copyright (c) 2019 Dow Jones & Company, Inc.