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Easy money spurs investors to take on risk again

Reid Hoffman, left, with glasses, the founder of LinkedIn, and Jeff Weiner, centre, the company's CEO, watch the listing of LinkedIn.

Mark Lennihan/AP

With the dark days of the market meltdown now more than two years behind us, investors have become emboldened again, even as economic data have turned more negative than a few months ago.

For a sense of investors' willingness to embrace risk, consider that LinkedIn Corp. , with $15.4-million (U.S.) in profit last year, commanded an $8.8-billion valuation two days after going public. Suddenly the phrase "dot-com bubble" is back in print.

Meanwhile, the junk bond market is on fire, with investor appetite for high yields almost insatiable. The issuance of speculative grade corporate bonds in Canada is on track to grow 60 per cent this year, to $6.1-billion (Canadian), according to CIBC World Markets Inc. In the U.S., issuance is on course to exceed last year's record $210-billion (U.S.).

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Underpinning a lot of investor confidence is the U.S. Federal Reserve and its policy of easy money. The Fed saved the economy with its asset-buying program in 2008 and 2009, and spurred the markets with its second round of quantitative easing that began late last year. The minutes from the Fed's monetary policy meeting released last week revealed more details about how the central bank will soon begin to reduce stimulative measures.

But the challenge for the Fed now is how to wean market junkies off loose money, without creating a rush to the exits. The Fed left the door open for a QE3 if the economy suddenly tanks, a move that has shrewd investors calculating that they have the world's biggest central bank to back them up if global macro conditions suddenly deteriorate.

Several economic reports disappointed last week, and this Wednesday we will likely hear that the recovery in U.S. manufacturing is losing steam. Economists expect that durable goods orders for April, which show new orders placed with U.S. manufacturers, declined by 2.4 per cent compared with a 4.1-per-cent increase the previous month.

On Friday, the U.S. Department of Commerce provides personal income and outlays data for April, which shows household income and expenditures. Economists expect that personal income grew less than spending for the third straight month. They are forecast to rise by 0.4 per cent and 0.5 per cent respectively.

At the moment there's "an unappealing combination of elevated sentiment and weakening economic data," notes Robert Kavcic, an economist with BMO Nesbitt Burns Inc. The stars seem aligned for a correction, he adds, and a lot of smart money is already moving into defensive stocks such as consumer staples, health care and utilities.

Jeremy Grantham, chief investment strategist of GMO LLC, a global investment management firm with more than $100-billion under management, says investors have ridden the Fed's coattails as they added risk to their portfolios. It's been a profitable strategy over the last six months. The S&P 500, which closed Friday at 1333, may reach 1,500 by Oct. 1, he told clients in his quarterly note. But "whether it will reach 1,500 or not, the environment has simply become too risky to justify prudent investors hanging around, hoping to get lucky. So now is not the time to float along with the Fed, but to fight it."

In Canada, several economists are now forecasting that the weakening economy and strengthening dollar mean the central bank won't move to raise rates until the end of the year, rather than this summer.

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Five of the Big Six banks report results this week, steering first-quarter reporting season to a close in Canada. Companies have delivered respectable gains, but not blown the doors off. David Madani, Canada economist for Capital Economics, estimates that first-quarter corporate operating profits grew by almost $4-billion (Canadian) to $69-billion, for an increase of about 6 per cent.

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