Markets shrug off Fed move-Is that a mistake?

Are stocks a bit too complacent when it comes to the Fed?

The S&P 500 (^GSPC) soared on Wednesday’s unexpectedly dovish Federal Reserve statement and projections, and the small-cap Russell 2000 (^RUT) actually rose to an all-time high. On Thursday, while the S&P gave back a bit of its gains, the Russell and Nasdaq (^IXIC) rose further.

But perhaps stocks shouldn’t celebrate a dovish Fed just yet.

“It was a temporary win for the bulls, but it only delayed the fight until a future date, because higher rates are most likely coming at some point,” Jeff Saut of Raymond James wrote in a note to clients. The Fed is clearly watching the data, “so unless we get a meaningful economic slowdown, we seem to be progressing, step-by-step, toward a rate hike sometime later in the year.”

For bond traders, old strategies ‘just won’t work’

For Lawrence McDonald , head of US strategy with Societe Generale’s macro group, the bulls have indeed become too complacent.

“Stock investors have been playing this successfully for a long time. They’ve been buying dips–several hundred dips have been bought, and they’ve been successful trades.”

That’s lead to a troubling psychological condition in which investors will take any excuse to buy dips in the future, McDonald diagnoses.

Indeed, there appears to be little fear in the market. The CBOE Volatility Index (^VIX), which measures how much investors are willing to pay for options in the S&P 500 and hence how worried they are about a major decline, closed Thursday at just 14, well below its classical mean reading of 20. Even November VIX futures are only trading at 19.

But perhaps the prospect of rate rises need not “frighten a lot of people,” as Saut notes that they appear to.

“I don’t think the market is too sanguine,” said Erin Gibbs, an equity chief investment officer with S&P Capital IQ. After all, “you can have rising equity markets with rising interest rates.”

Still, that doesn’t mean American stocks are a home run.

With the Fed looking to normalize policy, and the European Central Bank embarking on quantitative easing, “we could definitely see more relative attractiveness in Europe,” Gibbs said.

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