The number one topic for all investors remains interest rates. The return on cash is plumbing new lows and all forms of fixed interest are arguably returning negative real rates. For savers or those who rely on fixed income returns, this is a significant issue.

What most people struggle to understand is how can we be 10 years past the GFC and interest rates are still going down? A very fair question.

All Central Banks are “inflation targeting”, or in the Fed’s case, the dual mandate of employment and inflation, and inflation remains almost non-existent by traditional measures.

The next question becomes: is this a cyclical lull in inflation or a structural change to inflationary pressures? Have advances in technology eradicated inflationary pressure? Is this the “new normal” as such?

My view is we have entered a “new normal” of ultra-low interest rates. This will have long-term ramifications for asset allocation and how acceptable risk-adjusted investment returns are generated.

I believe that reductions in interest rates from Central Banks provide a constructive outlook for global equities, as investors look for returns beyond what (little) is earnt in bank deposits. I’m of the view “there is no alternative” (TINA) to equities as an asset class when you consider the outlook for total returns (capital growth plus dividend yield).

For context, the search for yield is becoming even more challenging. Globally, there is approximately $13 trillion of negative yielding Government bonds. This means that if you lend money to some major western Governments, they will return less money back to you in several years. We don’t like this return profile and much prefer to own some of the leading global companies that are forecast to compound in the coming years, at double-digit rates.

Source: AIM

One of the key causes for Central Bank action has been the lack of inflation. The reasons for this are debated and analysed by many but I thought it worthwhile to refer to a potential deflationary source, the “gig economy”. The gig economy is a segment of the workforce who don’t work typical 9 to 5 jobs but rather on a task-by-task basis, for multiple employers. In the US, there are 60 million people, or about 30% of the workforce, in the gig economy. This is a huge change. As more Millennials value autonomy and flexibility, the competition for work in many sectors is accelerating and, in many cases, is global, not local. For example, platforms such as Amazon Flex, Air Tasker, iTalki and Uber can accept people on their platforms almost instantly. The pricing power and competition for resources is putting pressure on wages in some sectors, as is the rise of automation and technological disruption.  We consider this to be a case of the old-v-new world.

Many of the facilitators of the “new world” are platform businesses that have hundreds of millions, if not, billions of users. They provide products that offer a network effect to users and make their lives more efficient in many ways. These businesses enable consumers to access goods, services and employment opportunities that have previously been unobtainable. The most obvious examples are some of the products we us use on a daily basis – Facebook, Google, Salesforce, LinkedIn, Alibaba and Tencent. These companies and others, which are represented in our portfolio, are growing at 20%+ per year. Whilst their growth is causing intended and unintended consequences across a range of sectors, the dominance and network effect of these companies is increasing, despite the macro uncertainty. We own many of these disruptors and avoid the disrupted. The bifurcation across major economies and between sectors is stark. In a world where headline growth or specific macro indicators may suggest weakness, we believe there is significant value in detailed research and analysis, as we hunt for opportunities.

The changes that are occurring everyday are pronounced. It is no surprise that 40% of Fortune 500 companies are expected to change in the next 15 years, as people value choice, autonomy and flexibility. As I search for opportunities globally, the goal is to be positioned to capture the future, not the past. We feel constructively optimistic owning the leading companies that disrupt, innovate and are led by visionaries. Global equities offer this to investors, as opposed to a Government Bond, where you pay for the privilege to lend your money to a Government.

Maybe I’m wrong on the causes of persistently stagnant inflation, but something is causing it and I tend to believe it is technology. The very last thing I’d do as an investor is “pay for the privilege to lend your money to a Government”. What I believe will prove more sensible and rewarding is buying the best structural growth stocks in the world and holding them for the next decade. The right global structural growth stocks will deliver double digit compound earnings and dividend growth while also buying back their own shares. Under a sustained period of ultra-low cash rates, the price paid (P/E) for those attributes will rise.

Global sectors that fit the “structural growth” theme include: software, internet retailing, platforms, cloud storage, social media, luxury goods, content streaming, healthcare, medical devices, recycling, wellness & health, cyber security, and payment systems to name a few. That is not an all-encompassing list but leads you towards sectors that a growing at multiples of GDP growth and delivering earnings and dividend growth at multiples of the S&P500 Index. I believe you simply have to own structural growth stocks in this environment, particularly those that can raise prices and expand margins.

That doesn’t mean we pay crazy multiples for structural growth. It requires discipline in terms of valuation. I believe the best valuation tool as such is the price to growth ratio (PEG ratio), where we are looking for prospective EPS growth to be very close to the forward P/E. I’m happy to pay 25x forward P/E for +25% EPS growth, give or take a few points.

These are far different attributes than are generally available in Australian equities. There aren’t many larger cap Australian equities offering +25% EPS growth. Globally, I can find hundreds of companies with 25%+ EPS growth and reasonable P/E’s. This is why I now have my lowest exposure to Australian equities ever. I am strongly of the view there are better opportunities outside Australia in sectors that aren’t represented in Australian equities (refer above).

The only Australian equity I own right now is the A2 Milk Co (A2M). I have sold out of Aristocrat (ALL) and Cleanaway (CWY) after they exceeded our valuations and became less attractive. I’ll write in detail about A2M in my next note and why I think it’s a solid medium-term investment.

All in all, I believe we all need to get our heads around what negative real yields mean for asset allocation.

With equities appearing more attractive relative to other asset classes, there’s a growing chance this equity bull market will extend, as money rotates into equities from cash and fixed interest. As I say, the next leg of this could simply be P/E expansion.

Let’s see what happens. As they say, bull markets climb the wall of worry. There’s plenty to worry about, as there always is, yet I tend to feel central bank actions are more powerful than “the wall of worry”. Don’t fight the Fed and always position for the future, not the past.