Fiduciary Trust International

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”Human ingenuity will overcome today’s problems and alert investors will benefit.”

The volatility of stock prices over the past decade can severely upset long-held investment beliefs. The technology bubble in 2000, the global credit crisis that began in 2007 and the deep recession that followed illustrated that the market’s ups and downs can happen quickly and pervasively.

Indeed, with the benefit of hindsight of the past ten years, some investors are turning their backs on equities now—after one of the worst decades the stock market has ever seen and the worst recession since the 1930s. So this history begs the question, are we likely to see a repeat of the past decade?

WE EXPECT THREE PROMISING THEMES TO PRESENT OPPORTUNITIES 

While we can always expect a certain level of volatility in the markets, we believe that a number of positive themes will unfold in the coming decade that will belie the performance of the past ten years and benefit equity investors.

1] INNOVATION: NEW ADVANCES WILL PROVIDE OPPORTUNITIES
Many innovations over the past decade have created enormous wealth, as well as disrupted well-defined industries: technological advancements (e.g., mobile telephony), new business models (e.g., instant media), medical discoveries (e.g., gene therapy) and other transformational changes (e.g., social media) are all good examples.

As new inventions have come to market, consumers have demonstrated a willingness to adopt them at an increasing pace. The evolution of music technology over the past 40 years illustrates this behavior. In the late 1960s, 8-track tapes made recorded music more portable; cassette tapes replaced 8-tracks and eventually became more popular than vinyl records; CDs quickly overtook cassettes and then were overtaken by digital music downloads in a short period of time (CHART 1).

We Expect Innovation to Benefit Many Industries in the Decade Ahead:

• Cloud Computing
  As data security measures and communication speeds improve we anticipate that computing power will become a commodity, termed “cloud computing,” and be rented as needed. Over time, we believe it will resemble the evolution of electricity production in the early twentieth century, and become concentrated among specialized companies. With cloud computing, PCs and company servers will simply become the interface accessing programs and data we rely on. As cloud computing takes hold, it offers the potential to reduce the cost of data processing.
  
  We expect several players within the cloud computing arena to benefit. Software companies are aggressively allocating resources to cloud-based initiatives. Hardware manufacturers, data storage and infrastructure providers, and application developers are also expected to see increased demand for their products and services.
  
  In addition, we anticipate that cloud computing will lower barriers for start-up firms, which will further fuel technological innovation. We expect to uncover numerous investment opportunities created by new providers of mobile applications, programs that increase efficiency in every stage of production, new e-commerce firms and many others.
  
  
• Healthcare, Gene Therapy and Regenerative Medicine
  Today, healthcare is a developed-world industry facing severe headwinds. For example, many leading pharmaceutical firms are rapidly losing sales as patent protections expire. Biotech firm revenues are concentrated in a limited number of drugs and new drug approval is difficult to predict. Healthcare administrative costs are high, and the industry’s multi-tiered health delivery structure resists efficiencies. Lastly, the impact of U.S. healthcare reform remains to be seen.
  
  In the coming decade, we anticipate global growth in the healthcare industry enabled by new products and technologies. The unsustainable growth of healthcare spending in the developed world will be curbed, creating investment opportunities in providers of generic drugs and specialized healthcare communications and technology firms. We expect drugs, diagnostics and technologies, such as non-invasive imaging, to grow.
  
  In addition, research is seeking to identify the genetic markers of disease and investigating ways to turn off “bad” genes. Researchers are also seeking to use the body’s own cells to regenerate diseased organs and slow the impact of aging. We expect innovations such as these to widely benefit the industry—and investors—over the coming years. 
  
  
• Robotics
  Huge strides have been made using robots to drive costs down and improve the effectiveness of numerous manufacturing processes. In healthcare for example, robots are increasing surgeons’ accuracy, shortening recovery times and reducing overall surgical and hospital costs. Other areas, including the military and law enforcement, are also expected to benefit.
  
  
• Nanotechnology
  Already widely used in coatings that resist scratches, stain-repellent fabrics and razor blades, we expect additional uses to continue to appear. Nanotechnology uses are invading and improving life’s most common recesses: Nano silver particles are now incorporated into socks and athletic wear to fight odors. Thus, we believe potential investment opportunities are indeed many.
  
  
• Green Energy
  As the prices of fossil fuels rises and the real costs of environmental impacts are recognized, we expect to see many opportunities for substitutes to oil and coal. Widespread use of hybrid cars is just one notable example. Local building codes requiring energy efficient construction offer huge investment potential. In our view, the rapid expansion of solar installations suggests significant opportunity in green energy. (CHART 2).

2] EMERGING MARKETS: DRIVERS OF GROWTH OPPORTUNITIES
Many developing nations have kick-started development with export-led policies. Low labor costs in emerging economies allowed the developed world to contain inflation and expand consumer choice. The development phase is now ending as Chinese, Indian and Brazilian populations, among others, assert demands to enjoy the fruits of their labor.

We anticipate the next development phase will be the rapid growth of domestic consumption in the emerging world. In our view, not only will there be numerous opportunities among companies meeting these demands, but exporters in the U.S. and elsewhere will benefit, sending branded consumer goods and other products into these markets (CHART 3).

High Demand from Developing Countries Will Drive Opportunity in Many Sectors: 

• Consumer Goods and Tourism
  Today, emerging markets represent 86% of the global population, but consume less than 40% of the world’s packaged goods. These consumers purchase one tenth as many staple products, spending approximately $200 per year versus $2,000 per year for consumers in developed markets.
  
  We believe retail sales for consumer packaged goods could climb tenfold as emerging market countries become wealthier. Products such as cosmetics, diapers, fragrances and laundry supplies have already experienced some of the fastest growth. We expect discretionary spending to continue to grow, supported by the projected 10.7% annual growth rate of Asian middle classes over the next 5 years.
  
  Tourism will also likely become a spending priority—Chinese and Indian populations are currently at the very early stages of this trend. Asian tourism is expected to grow by about 10% annually for the next five years, leading to increased spending on travel, luxury items, hotels and gaming.
  
  
• Telecommunications
  Mobile devices will likely overtake the PC as the most common tool to access the internet. Forecasts anticipate there will be 1.5 billion mobile internet users worldwide by 2013, and over 50 billion mobile devices are expected to be connected by 2020.
  
  The developing world will likely drive strong subscriber growth to mobile devices as these become increasingly significant, and indeed essential, to everyday life. For example, the Chinese government has established mobile infrastructure in nearly 26,000 villages to enable farmers to track weather conditions and product prices. In Kenya, one mobile provider already has 9 million subscribers to its money transfer service, allowing subscribers to open and operate a bank account, save, withdraw and access loans.
  
  Several charitable foundations are expected to fund mobile solutions focusing on vaccine delivery in various developing countries. Potential opportunity not only arises from the device and application makers, but also the companies creating the equipment to support, carry, manipulate, secure and store the expected massive data load.

• Infrastructure
  Infrastructure is another area we believe will benefit from emerging market growth. As countries gain wealth, they will likely experience many issues that developed nations struggle with—highway, air and seaport congestion, and increased demand for energy.
  
  We expect that high-speed and freight railway development will be a fast-growing infrastructure opportunity in many developing countries. China alone is expected to triple its railway infrastructure by 2020 (CHART 5).

• Energy
  Significant growth in emerging markets’ energy needs will also likely require large scale new infrastructure. We expect the push for low-carbon energy substitutes to drive increased natural gas production, necessitating pipeline development and exploration. Wind power is expected to have a high share in new capacity additions, and nuclear power will also likely regain share (CHARTS 6 & 7). And, as prices for solar power come down, we expect areas such as low-cost panel makers and polysilicon producers to benefit.

3] GLOBALIZATION: CREATING OPPORTUNITIES FOR U.S. AND NON-U.S. COMPANIES 
We believe the globalization of the world will continue to significantly reduce trade barriers, creating new markets and stimulating growth. The transition toward freer trade and global markets is unavoidably painful; but the momentum appears unstoppable despite recurring outcries. We believe U.S.-based and foreign-owned companies that recognize the advantageous opportunities from globalization will be attractive investments.

As usual, leading companies recognized the opportunity long ago and reorganized to capitalize on global growth. Indeed, these well known U.S. firms are literally world-class in sales:

LOOKING AHEAD
We expect to continue to favor multi-national companies that have leading market share, expanding margins, strong free cash flow, consistent earnings growth and low debt. In our view, many of these global leaders are positioned to benefit from the significant growth in the emerging markets. The credit crisis and recession forced well managed, forward-thinking companies to streamline operations and enter faster-growing markets to increase sales. Balance sheets of these firms are now strong, allowing them to fund future growth.

Dividends are important. We consider a company’s dividend payment history and its potential to pay future dividends as useful guides to its future and likely investment performance. We are looking for those high-quality companies that can fund ongoing growth and return cash to investors.

Equity markets have always been volatile and will likely continue to be. Yet, the long-term historical record for equities is generally superior to other asset classes and belies the experience of the past ten years. In our view, the next decade is sure to be both exciting and rewarding as the pace of innovation grows, driven by expanding global wealth and a growing understanding of the unsustainable costs of environmental degradation and health care. We see this awareness as opportunity as companies grapple with solutions. While it will take time to adjust, we believe that the strongest companies will prosper from change, and opportunities will continue to present themselves—as they always have.

This communication is intended to provide general information. The information and opinions stated are as of January 15, 2011 unless otherwise indicated, and do not represent a complete analysis of every material fact concerning any industry, security or investment. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether information in this newsletter may be appropriate for you. IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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