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Lockdowns aside, there has been a deluge of good news for investors to celebrate in 2021. Canadian and U.S. employment numbers are improving, factories are humming, commodity prices are rising and economic projections are growing rosier.

Leisure stocks and airlines are recovering with expectations of cash-rich, vaccinated consumers soon letting loose upon the world. U.S. banks are releasing massive financial reserves they had built up last year, and Canadian banks could follow.

Profits are soaring: For companies in the S&P 500 that have reported their first-quarter financial results so far, earnings have risen nearly 34 per cent from last year’s first quarter, according to Refinitiv. That’s the strongest growth in more than a decade.

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“I have little doubt that with excess savings, new stimulus savings, huge deficit spending, more [quantitative easing], a new potential infrastructure bill, a successful vaccine and euphoria around the end of the pandemic, the U.S. economy will likely boom,” Jamie Dimon, chief executive officer of JPMorgan Chase & Co., said in a much-discussed annual letter to shareholders this month.

So why is this a time to be cautious?

Apart from record-high levels for the S&P 500 and the S&P/TSX Composite Index this month, it’s becoming hard to ignore signs of investor complacency.

‘Be fearful when others are greedy’

That’s a quote from Warren Buffett – and although the billionaire investor and head of Berkshire Hathaway Inc. hasn’t said that he’s fearful right now, his company is sitting on US$138-billion in cash while less sophisticated investors appear to be devouring stocks.

The weekly sentiment survey from the American Association of Individual Investors is a good way to gauge what retail investors are thinking. In April, they have been extraordinarily enthusiastic about stocks.

In the three weekly readings so far this month, a majority of respondents said they feel bullish about the direction of the stock market over the next six months, a notable switch from being cautious over much of the stock market’s recovery over the prior year.

Indeed, 56.9 per cent of respondents said they felt bullish on April 7, marking the highest weekly reading in more than three years. Just 20.4 per cent felt bearish, the lowest reading in two years.

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Is this a contrarian indicator? Perhaps. After stocks plummeted last year to bear-market lows, small investors weren’t amused: The AAII’s sentiment survey showed that just 29.7 per cent of investors felt bullish in mid-March, 2020. In retrospect, it was a good time to buy.

Bonds, borrowing and bitcoin

Other measures point to ebullience, perhaps implying limited upside for stocks.

There are specific examples of risk-taking, like the perplexing rise of GameStop Corp. , up 700 per cent since the start of the year; or the appeal of bitcoin, up as much as 119 per cent year-to-date last week.

Then there are broader examples of rising confidence.

Investors are borrowing record amounts of money to take advantage of the rising stock market. According to the Financial Industry Regulatory Authority, or FINRA, debit balances in U.S. margin accounts reached a record high of US$822.6-billion in March. That’s up more than 46 per cent from January, 2020, before COVID-19 slammed into North America.

Bond spreads are compressing. Yields on high-risk speculative corporate debt are, as usual, higher than yields on ultra-safe U.S. Treasury bonds, but the difference has shrunk considerably – to just 335 basis points from more than 1,000 basis points during the stock market meltdown last year. (There are 100 basis points in a percentage point.)

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While the spread has been lower before, it’s very unusual to be this low when economic activity is still recovering.

“To justify where the spread is now, you have to be very confident about the extent of the recovery within a relatively short period,” Martin Fridson, chief investment officer at New York-based Lehmann Livian Fridson Advisors, said in an interview.

There was no alternative

If stocks looked like the only game in town when government bond yields were low and central banks were promising to keep their key interest rates at ultralow levels, that’s now changing.

The Bank of Canada announced this week that it could raise interest rates sooner than expected – perhaps starting in the second half of 2022, overriding its previous projection of 2023 because of stronger-than-expected economic growth.

“The Bank of Canada made a U-turn this week – from extreme caution in January to borderline extreme optimism now,” Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, said in a note.

Investors are now left wondering whether other central banks are about to make U-turns of their own, marking an eventual end to the extraordinary monetary stimulus of the past year.

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Ultralow rates have supported higher equity valuations, and technology stocks in particular have thrived in the low-rate environment. Higher rates could weigh on equity valuations.

“Stocks look expensive on all metrics except relative to bonds,” Savita Subramanian, equity and quant strategist at Bank of America, said recently in a note. But, she added, “even the TINA (there is no alternative) argument is fading.”

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