Coutts' Wong: Market Is Far Too Complacent About The Threat Of Inflationary Pressures

The majority of analysts are forecasting US core inflation to rise to 2% from its current 1.8% mark, but Wong said the Consumer Price Index (CPI) excluding food and energy could rise as high as 3%, which could force the Federal Reserve's hand in hiking rates.

Wong said Trump's Tax Cuts and Jobs Act, which has slashed corporation tax to 21% from 35%, will also provide a boost to inflation, as firms such as Walmart, Southwest Airlines and Wells Fargo have already announced plans to raise wages.

How five big US equity funds could fare in a rising inflation and rates environment

"We are not expecting US inflation to spike but inflationary pressures are clearly to the upside and the market is not pricing it in.

"We have had a 50% increase in the oil price since June, which will start feeding into US inflation," she said. 

"Earnings season has just started, which is where we will hear what companies will do with the tax cuts, and unemployment is at a record low of 4.1%. 

"The market is anchored in pricing in two to three rate hikes this year, so it does not take much in terms of an inflation surprise to cause the market to shift."

Wong said the biggest impact of a rise in inflation would be on the fixed income space, as solid growth and corporate earnings are still supporting equity markets.

In this inflationary environment, she said investors were not being properly compensated for investing in gilts at their current levels and even US 10-year yields at 2.5% are expensive compared to historical valuations.

Therefore, in order to protect portfolios in the post quantitative-easing (QE) world, where bonds and equities could both collapse, the firm has moved into alternatives such as long/short market neutral and momentum strategies.

"The alternative strategies we hold have near zero correlation to bonds and equities," Wong said. 

"Gilts used to play this role but in a post-QE world you could make the case that we could see a sell-off in bonds and equities simultaneously and as long-only investors, this is a challenge for us."

Japan

One area of the equity market on which the investment team is bullish is Japan, due to strong corporate earnings and cheap relative valuations.

"Corporate earnings rose 35% last year, but the Japanese equity market did not rise 35%," Wong said.

Japanese valuations remain attractive despite strong performance

"It is the one major market where you have had good corporate earnings, good macro and cheap currency and the market has de-rated slightly. 

"Furthermore, equity valuations are at a P/E ratio of 14x compared to 19x in the US," she added.