Issue 24: 2013

Future Perspective

The Big Five

Mega investment themes for the next decade.

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“We appear to be at the beginning of a new long-term growth phase for the U.S. economy, driven in large part by the rebalancing of global growth from the developed to the developing world,” says U.S. Trust Chief Investment Officer Chris Hyzy. “Not surprisingly, this broad-based shift is complex and often confusing. It involves changing demographics and, most importantly, a large mass of new consumers in countries developing a middle-class.”  

Demographic changes, the movement of capital around the world and the related political pressures are all creating imbalances: a public sector in recession while the private sector is driving the recovery; the healing U.S. consumer; the aging of Japan; still-high, if falling, unemployment in the United States; the U.S. deficit and the long-term entitlements issue; the breakdown and rebuilding of the housing market; Europe’s struggling financial system and austerity programs; China’s transformation from an investment and export-based economy to an economy led by domestic demand; and the depletion of natural resources shifting to the buildup of natural resources and the prospect of energy independence in the United States.

“These imbalances are all part of the changing nature of global growth, and they inevitably create some interim havoc with equity markets, interest rates, currencies and economies,” says Hyzy. “But with so much of the world in flux, with so many powerful and overlapping trends, where and how do we find appropriate investments? As investors, how can we best participate in these powerful changes? Rather than focusing on individual sectors — a more narrow and traditional approach — we first look at the long-term growth drivers, the macro forces at play across industries and geographies that are going to take us into the next secular growth cycle. U.S. Trust’s Investment Strategy Committee has identified five long-term investment themes: the accelerating change in technology and economic innovation; the energy and natural resources revolution; the rise of the emerging markets middle-class consumer; the great global income convergence and demographic transformation; and the evolution of global real estate.”

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1. THE ACCELERATING CHANGE IN TECHNOLOGY
AND ECONOMIC INNOVATION

“While all five macro themes will influence one another, technological change is arguably the most powerful and pervasive,” says Joe Quinlan, managing director and chief market strategist at U.S. Trust. After accelerating relatively slowly over the past few centuries, the pace of technological change has been increasing rapidly in recent decades, he says, adding that it will soon strain human capacity to anticipate developments even a decade ahead. The implication is a much faster-changing, harder-to-comprehend future. “This means a much murkier outlook over investment horizons and a much faster pace of creative destruction that can quickly turn a high-flying equity market winner into an obsolete investment dog.” In other words, according to Quinlan, while rapid technological change is likely to be a positive force for global growth, it will also create turbulence — both positive and negative — for investors. “We see technological change having a major impact on a wide range of areas in the global economy — and on manufacturing in particular.”

The U.S. Manufacturing Renaissance and New Production Technologies
Perhaps the defining characteristic of today’s globalization in trade and manufacturing is the global supply chain — the international network of people and activities that are involved in turning natural resources into final products. The significant geographic trend that has run concurrently with this rise of the global supply chain in recent decades has been a shift in the location of global manufacturing from West to East, particularly from the United States to China and other emerging economies. Faced with a new global market for labor, large U.S. manufacturers have increasingly elected for offshore assembly of final products to take advantage of lower-cost territories, which has contributed — along with other factors, such as technology and rising productivity — to a steady decline in domestic manufacturing employment. “But ultimately,” says Quinlan, “the choice of where to manufacture will be determined by the sum total of the costs and benefits of different production locations.”

THE PACE OF TECHNOLOGICAL CHANGE HAS BEEN INCREASING RAPIDLY IN RECENT DECADES.

Increasing cost convergence and new labor-saving technologies (robotics and additive manufacturing) are conspiring to reverse the offshoring trend. The Boston Consulting Group expects China to converge with parts of the United States — that is, it will no longer offer a cost advantage to U.S. firms — as early as 2015 for a range of product types, including electronics, machinery, appliances, electrical equipment and furniture. As a result, U.S. Trust expects more companies to begin to “re-shore” or “near-shore” — that is, to perform more of their manufacturing closer to home.

Big Data and Analytics 
The data center has experienced a renaissance from a formerly lethargic, fixed and hot mainframe layout to a flexible, light, scalable and shared resource. With the massive influx of data generated from every touch point across the economy — such as point-of-sale retail, delivery trucks, security camera networks and sensors installed in every physical device — sophisticated tools to store, sort, “de-duplicate,” cleanse, back up and tag these large data sets are in high demand by enterprises. Business intelligence applications will enable organizations to identify patterns, offer multiscenario models, predict outcomes, and ultimately deliver clean and readable reports to high-level decisionmakers. Research from information tech research and advisory firm Gartner indicates that big data and its related analytics applications will be a primary growth driver of the nearly $3.9 trillion expected to be spent on global IT in 2014. U.S. Trust’s Investment Strategy Committee thinks the vendors of these advanced applications will help transform how their cross-sector customers in both consumer and enterprise markets make decisions for the benefit of society, company profits and, ultimately, shareholders.

Cybersecurity
The effects of an invisible intruder can disable and disrupt economies, political systems, private organizations and even the environment. Hackers, spammers and cyber terrorists devise malicious cyber strategies to debilitate networks and steal (and sell) high-value information. The content can damage consumers’ financial accounts, uncover classified diplomatic cables or launch codes to defense systems. Today, not only are governments cyber-spying on each other, but cyber espionage is also directed at companies in the private sector to uncover trade secrets and strategic plans. CIOs consistently rank cybersecurity applications as a top item in their IT budgets. Gartner estimates that global technology spending on security could reach $86 billion by 2016, including software, services and network appliances. “Software vendors that specialize in cybersecurity should benefit,” says Quinlan.

Mobility
Multiple enablers have contributed to the proliferation of mobile devices in society in terms of providing innovation in feature sets, wireless network advances and application ecosystems (most notably, the App Store — an electronic storefront selling a plethora of entertainment and productivity software). Global telecommunication capital expenditures (CAPEX) fluctuate and are cyclical, unfortunately; however, the mix has clearly transitioned from fixed line to wireless investments in the overall global telecommunication infrastructure. “Because of the intense market competition in the mobile market, careful focus on the key leaders and added-value players is required,” says Quinlan. “While currently much of the value is in the chipsets, we think the overall ecosystem and software (app stores) will drive ubiquitous mobile engagement, and that investors will gradually lose focus on the physical handset and increasingly value the engagement capabilities of their devices.”

Investment Opportunities
Technological change is one of the few constants in a rapidly evolving global economy; it is both enabling companies to make profitable shifts in their production decisions and allowing them to respond to a number of today’s major economic trends, such as increased cybersecurity and the proliferation of digital information. Mobile, local and social trends are growing rapidly and have the ability to change the natural interaction and decision-making across the globe. Says Quinlan: “Investors stand to benefit from exposure both to those companies that are at the cutting edge of the development, design and marketing of these new technologies and to those companies that can harness them in their operations and production decisions to reduce operational costs and offer improved customer service. This includes a number of companies within the information technology sector, as well as a range of manufacturers, diversified chemical companies and industrial conglomerates.”

2. THE ENERGY AND NATIONAL RESOURCES REVOLUTION

“Demographics, globalization, governance, natural resources and technology have all come together for decades to shape energy markets,” says Irene Peters, a U.S. Trust analyst. “Demographics and globalization are driving global energy demand, and substantial investment in energy is critical to keep pace with that growing demand.” That more than half the world has never driven a car and that 20% of the world still has no access to electricity point to considerable upside potential for global energy demand. China alone will require incremental electric power generation equivalent to current combined U.S. and Japanese consumption over the next two decades.

LARGE AND SUSTAINED INVESTMENT IN ENERGY TECHNOLOGY AND INFRASTRUCTURE WILL BE NECESSARY IN THE COMING DECADES.

Over the years, advances in energy technologies have helped to resolve the problem of insufficient energy supplies. Peters notes that the U.S. shale gas revolution is a prime example of technological advancement resulting in expanding energy production, despite rapid depletion of conventional resources and obstructive governance.

To satisfy future global energy demand and produce energy from unconventional resources, large and sustained investment in energy technology and infrastructure will be necessary in the coming decades, according to Peters. The International Energy Agency (IEA) estimates that a cumulative $37 trillion (in 2011 dollars) will have to be allocated to the discovery, development and efficient delivery of both traditional and new, environmentally friendly energy sources in the 2012–2035 period. “The oil and gas industry is projected to absorb half of this estimated investment,” she says. “Another roughly 45%, or $17 trillion, of investments will likely be required by the power-generation sector for generation, transmission and distribution. Segments of the energy industry experiencing increased investment to meet global energy demands include ultra-deepwater drilling, hydraulic fracturing in shale formations, heavier crude refining (Canadian tar sands crude), midstream pipeline infrastructure, liquefied natural gas processing, storage facilities, and rail transportation of liquid fuels.”

Water
Drought conditions are growing more severe in many parts of the world, while the pace of global urbanization has accelerated, straining the water infrastructures of many nations to their breaking points. Population growth and urbanization are expected to push demand for water up 40% within 20 years, according to the World Bank. Governments are being driven to improve infrastructure while focusing on improving water supply and enhancing the effectiveness of wastewater treatment and recycling. Developed countries will likely need to focus investments on the maintenance and technological development of existing water infrastructure; developing countries need to ensure that the development of infrastructure keeps pace with their population growth and hence increasing demands on agriculture.

Says Peters: “Around the world, capital expenditures on building and improving water filtration, wastewater treatment, desalination, rural water services, water utilities, water utility performance, irrigation systems and a host of related projects are poised to increase sharply during the next decade.”

Agricultural Commodities
With United Nations estimates of world population expected to exceed 9 billion people by 2050,1 and with per capita incomes rising in key developing countries, Peters is expecting to see growing demand for diets rich in protein. Says Peters: “Given the combination of these demographic trends  and environmental factors, such as volatile weather, water scarcity and competition for arable land, U.S. Trust remains bullish long term on agricultural commodities and global multinational companies that manufacture agricultural products and equipment. Many food grain growers and large U.S. agricultural companies (both public and private) have benefited from this trend, which we expect to continue in the years to come.”

Investment Opportunities
As the global rebalancing story evolves, the current and future global growth engines will demand more natural resources. “Rather than target specific countries,” says Peters, “investors should seek to benefit from industries with the capabilities and technologies to meet future global demand for natural resources. A number of natural-resources-related industries are well positioned for this resource revolution and contain multinational companies that are well positioned to deliver on the world’s natural resource needs.” Among the areas that stand to benefit, she says, are the integrated oil and refining sectors, oil and gas exploration and production, oil services, railroads, engineering and construction, water infrastructure and agricultural subsectors.

3. THE RISE OF THE EMERGING MARKETS MIDDLE-CLASS CONSUMER

It is clear that global companies can no longer rely solely on developed-world consumers to drive future growth in earnings, given that in many countries these consumers face still-depressed home values, high levels of household debt, deleveraging governments, persistently high unemployment, slow disposable income growth and stagnant populations. Quinlan explains: “A major shift in the balance of global consumption is now under way. Already a major force on the global scene, the emerging markets consumer is set to become one of the principal drivers of world sales across a range of sectors. As incomes rise and the emerging middle class grows, companies that can capture this demand growth — both local entities and foreign multinationals — stand to benefit.”

Broadening the Base
In a range of markets, the emerging world has already overtaken the developed world in terms of absolute size. Emerging markets now account for over 62% of global energy consumption,2 62% of global meat consumption,3 close to 90% of global vegetable consumption and 79% of global fruit consumption, respectively.4 The story is essentially the same across commodities — the prices of copper, iron ore, corn, wheat and soybeans are heavily influenced by emerging market demand. However, according to United Nations data from 2011, the emerging market share of global personal consumption overall is still just 36%; while up significantly from 22% in 1990, this figure suggests still-significant scope for demand to broaden to discretionary consumer goods and services regarded as mainstays of a Western lifestyle today, such as transportation, personal care, banking, retail healthcare, technology and social media. According to research from global management consulting firm McKinsey, the number of people earning more than $10 per day — the level that affords households the ability to purchase discretionary items such as refrigerators or televisions — rose from roughly 1.2 billion people in 1990 to 2.4 billion people in 2010. By 2025, the number is expected to grow to 4.2 billion consumers.

IN A RANGE OF MARKETS, THE EMERGING WORLD HAS ALREADY OVERTAKEN THE DEVELOPED WORLD IN TERMS OF ABSOLUTE SIZE.

Investment Opportunities
“Increasing incomes, large and youthful populations, rising urbanization rates and a growing taste for global brands will all make the emerging markets consumer a critical demand driver for global companies in the coming years,” says Quinlan. “In particular, companies that can continue to address emerging market demand for agricultural produce, as well as those that can capture rising protein and calorie intakes and the shift toward a higher penetration of manufactured consumer goods, are well positioned. ‘Womenomics’ and mobile, local and social trends are growing rapidly and have the ability to change natural interaction and decision-making across the globe. We also expect global brands in a range of industries — including apparel, personal care, automotive and luxury — to benefit from this theme.”

4. THE GREAT GLOBAL INCOME CONVERGENCE AND
DEMOGRAPHIC TRANSFORMATION

As Western economic policymakers know well, demographic trends occur slowly, but surely. The ongoing debates in the United States, for instance, over the outlook for Social Security, state pensions and healthcare costs are all in some way related to the changing demographic profile of the country. “But such changes are of course not limited to the developed world,” says Quinlan, “and thus we should also consider the impact of demographic and social change in the broader global economy.”

Globalization has been highly beneficial for developing countries as their incomes and living standards have converged with those seen in industrialized nations.

“But just as the economic advantages associated with a Western lifestyle can be transmitted across borders, so can some of the challenges,” notes Quinlan. “The emerging world is also seeing increases in obesity and other health problems that tend to come with rising rates of urbanization, growing caloric intake and increasing life expectancy. Over the coming years, dealing with these challenges will require the same medical and technological solutions that many countries in the developed world have to apply today.”

A demographic convergence is also taking place within countries. Through a combination of changing social norms, higher educational attainment and new skills required in the modern workplace, for example, the economic influence of women is increasing around the world. These are changes that will be with us long into the future, but the trends are already under way.

Investment Opportunities
The changing global demographic profile is a long-term trend, but one that requires public policymakers and private companies to adjust their strategies now. The countries that can provide the best healthcare outcomes with the greatest efficiency and at the lowest cost, and those companies that can cater to the needs of an aging population and the increasing economic empowerment of women around the world today, will be those that emerge as the most competitive companies of tomorrow. A number of companies within the healthcare, consumer and technology sectors should be beneficiaries of these themes.

5. THE EVOLUTION OF GLOBAL REAL ESTATE

“An often overlooked fact of the financial crisis of 2008 and 2009 is the global nature of the real estate market correction, for both residential and commercial real estate,” says Hyzy. “We think a recovery is under way, led by a well-entrenched residential recovery in the United States, positive long-term fundamentals for commercial real estate in emerging Asia, and the global reach for yield investments.”

“We have long thought of real estate as a guidepost for domestic economic cycles,” Hyzy continues. “But many of the factors that are important for growth in real estate demand and construction are secular in nature. Demographics and, more specifically, adult population growth, for example, form the basis for household formation. As we move deeper into a global real estate expansion, the secular macro tailwinds are a good starting point for sorting through potential long-term winners and losers.

“In the United States, a well-entrenched cyclical recovery characterized by falling unemployment and rising wages is now in place, and when this is combined with record-low inventories of existing homes along with new-home starts well below levels commanded by still-positive demographics, real estate investment should be in an upswing for years to come,” Hyzy says. “Commercial real estate should follow suit and may have the strongest upside potential at this stage. Outside the United States, emerging markets are increasing their market share in global commercial real estate, led by their growing middle class, positive demographics and relatively higher levels of growth. In Japan, the Bank of Japan’s long-awaited, aggressive reflationary efforts are a positive catalyst for real estate investments, often perceived as an inflation hedge.”

Investment Opportunities
The combination of healthy demographics, greater transparency, a growing consumer base and increasing crossborder capital flows suggests that the emerging markets will be an attractive area in which investors can seek commercial real estate opportunities over the next few years, according to U.S. Trust’s Investment Strategy Committee. A growing set of institutional-grade opportunities and an increase in securitization are reasons for continued optimism.

“We would specifically focus on the Asia-Pacific region,” says Hyzy, “but the U.S. commercial market also appears poised for growth. The domestic story (both residential and commercial) is positive not only for homebuilders, home improvement stores and building material providers, but for financial and consumer companies that should benefit as well. In Europe, opportunities to invest in distressed properties continue to develop.”

Riding the Tailwinds of Change
“These five major investment themes — and their numerous subthemes — are all propelled by the powerful and ongoing rebalancing of the global economy,” says Hyzy. “And they are by no means discrete. In many ways, they overlap and influence each other — sometimes positively, sometimes negatively. They touch multiple sectors and industries, and they will proceed at varying speeds as they develop. Together, though, they embody the major fundamental changes, the flux and evolution of the global economy in the next decade.

“At U.S. Trust, we believe these themes can help to provide us with the broad multi-industry context that we need to better understand the breadth of the economy’s changes. They help us to drill down more effectively into sectors, industries and individual investments, allowing us to avoid those areas and companies that are likely to be left behind so we can better position ourselves to benefit from the powerful tailwinds of change we expect to see in the years ahead.”

1Source: United Nations World Population Prospects Report, 2012 revision.
2Source: British Petroleum, 2012.
3Source: U.S. Department of Agriculture, 2012.
4Source: Food and Agriculture Organization, 2012.

IMPORTANT INFORMATION

Projections made may not come to pass due to market conditions and fluctuations.

Investing involves risk. There is always the potential of losing money when you invest in securities.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not assure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Stocks of small and mid cap companies pose special risks, including possible illiquidity and greater price volatility, than stocks of larger, more established companies.

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Commodities
Trading in commodities, such as gold, is speculative and can be extremely volatile. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest-rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Tangible assets can fluctuate with supply and demand, such as commodities, which are liquid investments unlike most other tangible investments.

Energy and natural resources stocks have been volatile. They may be affected by rising interest rates and inflation and can also be affected by factors such as natural events (for example, earthquakes or fires) and international politics.

Other
Nonfinancial assets, such as closely held businesses, real estate, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks, including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors.

Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties, such as rental defaults.

DEMOGRAPHICS “Changes are of course not limited to the developed world, and thus we should also consider the impact of demographic and social change in the broader global economy.”
–Joe Quinlan, U.S. Trust

TECHNOLOGY AND INNOVATION “While all five macro themes will influence one another, technological change is arguably the most powerful and pervasive.”
–Joe Quinlan, U.S. Trust

ENERGY AND NATURAL RESOURCES “Demographics, globalization, governance, natural resources and technology have all come together for decades to shape energy markets.”
–Irene Peters, U.S. Trust

EMERGING MIDDLE-CLASS CONSUMERS “Already a major force on the global scene, the emerging markets middle-class consumer is set to become one of the principal drivers of world sales across a range of sectors.”
–Joe Quinlan, U.S. Trust

GLOBAL REAL ESTATE “An often overlooked fact of the financial crisis of 2008 and 2009 is the global nature of the real estate market correction, for both residential and commercial real estate.”
–Chris Hyzy, U.S. Trust

“We appear to be at the beginning of a new long-term growth phase for the U.S. economy, driven in large part by the rebalancing of global growth from the developed to the developing world,” says U.S. Trust Chief Investment Officer Chris Hyzy. “Not surprisingly, this broad-based shift is complex and often confusing. It involves changing demographics and, most importantly, a large mass of new consumers in countries developing a middle-class.”  

Demographic changes, the movement of capital around the world and the related political pressures are all creating imbalances: a public sector in recession while the private sector is driving the recovery; the healing U.S. consumer; the aging of Japan; still-high, if falling, unemployment in the United States; the U.S. deficit and the long-term entitlements issue; the breakdown and rebuilding of the housing market; Europe’s struggling financial system and austerity programs; China’s transformation from an investment and export-based economy to an economy led by domestic demand; and the depletion of natural resources shifting to the buildup of natural resources and the prospect of energy independence in the United States.

“These imbalances are all part of the changing nature of global growth, and they inevitably create some interim havoc with equity markets, interest rates, currencies and economies,” says Hyzy. “But with so much of the world in flux, with so many powerful and overlapping trends, where and how do we find appropriate investments? As investors, how can we best participate in these powerful changes? Rather than focusing on individual sectors — a more narrow and traditional approach — we first look at the long-term growth drivers, the macro forces at play across industries and geographies that are going to take us into the next secular growth cycle. U.S. Trust’s Investment Strategy Committee has identified five long-term investment themes: the accelerating change in technology and economic innovation; the energy and natural resources revolution; the rise of the emerging markets middle-class consumer; the great global income convergence and demographic transformation; and the evolution of global real estate.”

1. THE ACCELERATING CHANGE IN TECHNOLOGY
AND ECONOMIC INNOVATION

“While all five macro themes will influence one another, technological change is arguably the most powerful and pervasive,” says Joe Quinlan, managing director and chief market strategist at U.S. Trust. After accelerating relatively slowly over the past few centuries, the pace of technological change has been increasing rapidly in recent decades, he says, adding that it will soon strain human capacity to anticipate developments even a decade ahead. The implication is a much faster-changing, harder-to-comprehend future. “This means a much murkier outlook over investment horizons and a much faster pace of creative destruction that can quickly turn a high-flying equity market winner into an obsolete investment dog.” In other words, according to Quinlan, while rapid technological change is likely to be a positive force for global growth, it will also create turbulence — both positive and negative — for investors. “We see technological change having a major impact on a wide range of areas in the global economy — and on manufacturing in particular.”

The U.S. Manufacturing Renaissance and New Production Technologies
Perhaps the defining characteristic of today’s globalization in trade and manufacturing is the global supply chain — the international network of people and activities that are involved in turning natural resources into final products. The significant geographic trend that has run concurrently with this rise of the global supply chain in recent decades has been a shift in the location of global manufacturing from West to East, particularly from the United States to China and other emerging economies. Faced with a new global market for labor, large U.S. manufacturers have increasingly elected for offshore assembly of final products to take advantage of lower-cost territories, which has contributed — along with other factors, such as technology and rising productivity — to a steady decline in domestic manufacturing employment. “But ultimately,” says Quinlan, “the choice of where to manufacture will be determined by the sum total of the costs and benefits of different production locations.”

THE PACE OF TECHNOLOGICAL CHANGE HAS BEEN INCREASING RAPIDLY IN RECENT DECADES.

Increasing cost convergence and new labor-saving technologies (robotics and additive manufacturing) are conspiring to reverse the offshoring trend. The Boston Consulting Group expects China to converge with parts of the United States — that is, it will no longer offer a cost advantage to U.S. firms — as early as 2015 for a range of product types, including electronics, machinery, appliances, electrical equipment and furniture. As a result, U.S. Trust expects more companies to begin to “re-shore” or “near-shore” — that is, to perform more of their manufacturing closer to home.

Big Data and Analytics 
The data center has experienced a renaissance from a formerly lethargic, fixed and hot mainframe layout to a flexible, light, scalable and shared resource. With the massive influx of data generated from every touch point across the economy — such as point-of-sale retail, delivery trucks, security camera networks and sensors installed in every physical device — sophisticated tools to store, sort, “de-duplicate,” cleanse, back up and tag these large data sets are in high demand by enterprises. Business intelligence applications will enable organizations to identify patterns, offer multiscenario models, predict outcomes, and ultimately deliver clean and readable reports to high-level decisionmakers. Research from information tech research and advisory firm Gartner indicates that big data and its related analytics applications will be a primary growth driver of the nearly $3.9 trillion expected to be spent on global IT in 2014. U.S. Trust’s Investment Strategy Committee thinks the vendors of these advanced applications will help transform how their cross-sector customers in both consumer and enterprise markets make decisions for the benefit of society, company profits and, ultimately, shareholders.

Cybersecurity
The effects of an invisible intruder can disable and disrupt economies, political systems, private organizations and even the environment. Hackers, spammers and cyber terrorists devise malicious cyber strategies to debilitate networks and steal (and sell) high-value information. The content can damage consumers’ financial accounts, uncover classified diplomatic cables or launch codes to defense systems. Today, not only are governments cyber-spying on each other, but cyber espionage is also directed at companies in the private sector to uncover trade secrets and strategic plans. CIOs consistently rank cybersecurity applications as a top item in their IT budgets. Gartner estimates that global technology spending on security could reach $86 billion by 2016, including software, services and network appliances. “Software vendors that specialize in cybersecurity should benefit,” says Quinlan.

Mobility
Multiple enablers have contributed to the proliferation of mobile devices in society in terms of providing innovation in feature sets, wireless network advances and application ecosystems (most notably, the App Store — an electronic storefront selling a plethora of entertainment and productivity software). Global telecommunication capital expenditures (CAPEX) fluctuate and are cyclical, unfortunately; however, the mix has clearly transitioned from fixed line to wireless investments in the overall global telecommunication infrastructure. “Because of the intense market competition in the mobile market, careful focus on the key leaders and added-value players is required,” says Quinlan. “While currently much of the value is in the chipsets, we think the overall ecosystem and software (app stores) will drive ubiquitous mobile engagement, and that investors will gradually lose focus on the physical handset and increasingly value the engagement capabilities of their devices.”

Investment Opportunities
Technological change is one of the few constants in a rapidly evolving global economy; it is both enabling companies to make profitable shifts in their production decisions and allowing them to respond to a number of today’s major economic trends, such as increased cybersecurity and the proliferation of digital information. Mobile, local and social trends are growing rapidly and have the ability to change the natural interaction and decision-making across the globe. Says Quinlan: “Investors stand to benefit from exposure both to those companies that are at the cutting edge of the development, design and marketing of these new technologies and to those companies that can harness them in their operations and production decisions to reduce operational costs and offer improved customer service. This includes a number of companies within the information technology sector, as well as a range of manufacturers, diversified chemical companies and industrial conglomerates.”

2. THE ENERGY AND NATIONAL RESOURCES REVOLUTION

“Demographics, globalization, governance, natural resources and technology have all come together for decades to shape energy markets,” says Irene Peters, a U.S. Trust analyst. “Demographics and globalization are driving global energy demand, and substantial investment in energy is critical to keep pace with that growing demand.” That more than half the world has never driven a car and that 20% of the world still has no access to electricity point to considerable upside potential for global energy demand. China alone will require incremental electric power generation equivalent to current combined U.S. and Japanese consumption over the next two decades.

LARGE AND SUSTAINED INVESTMENT IN ENERGY TECHNOLOGY AND INFRASTRUCTURE WILL BE NECESSARY IN THE COMING DECADES.

Over the years, advances in energy technologies have helped to resolve the problem of insufficient energy supplies. Peters notes that the U.S. shale gas revolution is a prime example of technological advancement resulting in expanding energy production, despite rapid depletion of conventional resources and obstructive governance.

To satisfy future global energy demand and produce energy from unconventional resources, large and sustained investment in energy technology and infrastructure will be necessary in the coming decades, according to Peters. The International Energy Agency (IEA) estimates that a cumulative $37 trillion (in 2011 dollars) will have to be allocated to the discovery, development and efficient delivery of both traditional and new, environmentally friendly energy sources in the 2012–2035 period. “The oil and gas industry is projected to absorb half of this estimated investment,” she says. “Another roughly 45%, or $17 trillion, of investments will likely be required by the power-generation sector for generation, transmission and distribution. Segments of the energy industry experiencing increased investment to meet global energy demands include ultra-deepwater drilling, hydraulic fracturing in shale formations, heavier crude refining (Canadian tar sands crude), midstream pipeline infrastructure, liquefied natural gas processing, storage facilities, and rail transportation of liquid fuels.”

Water
Drought conditions are growing more severe in many parts of the world, while the pace of global urbanization has accelerated, straining the water infrastructures of many nations to their breaking points. Population growth and urbanization are expected to push demand for water up 40% within 20 years, according to the World Bank. Governments are being driven to improve infrastructure while focusing on improving water supply and enhancing the effectiveness of wastewater treatment and recycling. Developed countries will likely need to focus investments on the maintenance and technological development of existing water infrastructure; developing countries need to ensure that the development of infrastructure keeps pace with their population growth and hence increasing demands on agriculture.

Says Peters: “Around the world, capital expenditures on building and improving water filtration, wastewater treatment, desalination, rural water services, water utilities, water utility performance, irrigation systems and a host of related projects are poised to increase sharply during the next decade.”

Agricultural Commodities
With United Nations estimates of world population expected to exceed 9 billion people by 2050,1 and with per capita incomes rising in key developing countries, Peters is expecting to see growing demand for diets rich in protein. Says Peters: “Given the combination of these demographic trends  and environmental factors, such as volatile weather, water scarcity and competition for arable land, U.S. Trust remains bullish long term on agricultural commodities and global multinational companies that manufacture agricultural products and equipment. Many food grain growers and large U.S. agricultural companies (both public and private) have benefited from this trend, which we expect to continue in the years to come.”

Investment Opportunities
As the global rebalancing story evolves, the current and future global growth engines will demand more natural resources. “Rather than target specific countries,” says Peters, “investors should seek to benefit from industries with the capabilities and technologies to meet future global demand for natural resources. A number of natural-resources-related industries are well positioned for this resource revolution and contain multinational companies that are well positioned to deliver on the world’s natural resource needs.” Among the areas that stand to benefit, she says, are the integrated oil and refining sectors, oil and gas exploration and production, oil services, railroads, engineering and construction, water infrastructure and agricultural subsectors.

3. THE RISE OF THE EMERGING MARKETS MIDDLE-CLASS CONSUMER

It is clear that global companies can no longer rely solely on developed-world consumers to drive future growth in earnings, given that in many countries these consumers face still-depressed home values, high levels of household debt, deleveraging governments, persistently high unemployment, slow disposable income growth and stagnant populations. Quinlan explains: “A major shift in the balance of global consumption is now under way. Already a major force on the global scene, the emerging markets consumer is set to become one of the principal drivers of world sales across a range of sectors. As incomes rise and the emerging middle class grows, companies that can capture this demand growth — both local entities and foreign multinationals — stand to benefit.”

Broadening the Base
In a range of markets, the emerging world has already overtaken the developed world in terms of absolute size. Emerging markets now account for over 62% of global energy consumption,2 62% of global meat consumption,3 close to 90% of global vegetable consumption and 79% of global fruit consumption, respectively.4 The story is essentially the same across commodities — the prices of copper, iron ore, corn, wheat and soybeans are heavily influenced by emerging market demand. However, according to United Nations data from 2011, the emerging market share of global personal consumption overall is still just 36%; while up significantly from 22% in 1990, this figure suggests still-significant scope for demand to broaden to discretionary consumer goods and services regarded as mainstays of a Western lifestyle today, such as transportation, personal care, banking, retail healthcare, technology and social media. According to research from global management consulting firm McKinsey, the number of people earning more than $10 per day — the level that affords households the ability to purchase discretionary items such as refrigerators or televisions — rose from roughly 1.2 billion people in 1990 to 2.4 billion people in 2010. By 2025, the number is expected to grow to 4.2 billion consumers.

IN A RANGE OF MARKETS, THE EMERGING WORLD HAS ALREADY OVERTAKEN THE DEVELOPED WORLD IN TERMS OF ABSOLUTE SIZE.

Investment Opportunities
“Increasing incomes, large and youthful populations, rising urbanization rates and a growing taste for global brands will all make the emerging markets consumer a critical demand driver for global companies in the coming years,” says Quinlan. “In particular, companies that can continue to address emerging market demand for agricultural produce, as well as those that can capture rising protein and calorie intakes and the shift toward a higher penetration of manufactured consumer goods, are well positioned. ‘Womenomics’ and mobile, local and social trends are growing rapidly and have the ability to change natural interaction and decision-making across the globe. We also expect global brands in a range of industries — including apparel, personal care, automotive and luxury — to benefit from this theme.”

4. THE GREAT GLOBAL INCOME CONVERGENCE AND
DEMOGRAPHIC TRANSFORMATION

As Western economic policymakers know well, demographic trends occur slowly, but surely. The ongoing debates in the United States, for instance, over the outlook for Social Security, state pensions and healthcare costs are all in some way related to the changing demographic profile of the country. “But such changes are of course not limited to the developed world,” says Quinlan, “and thus we should also consider the impact of demographic and social change in the broader global economy.”

Globalization has been highly beneficial for developing countries as their incomes and living standards have converged with those seen in industrialized nations.

“But just as the economic advantages associated with a Western lifestyle can be transmitted across borders, so can some of the challenges,” notes Quinlan. “The emerging world is also seeing increases in obesity and other health problems that tend to come with rising rates of urbanization, growing caloric intake and increasing life expectancy. Over the coming years, dealing with these challenges will require the same medical and technological solutions that many countries in the developed world have to apply today.”

A demographic convergence is also taking place within countries. Through a combination of changing social norms, higher educational attainment and new skills required in the modern workplace, for example, the economic influence of women is increasing around the world. These are changes that will be with us long into the future, but the trends are already under way.

Investment Opportunities
The changing global demographic profile is a long-term trend, but one that requires public policymakers and private companies to adjust their strategies now. The countries that can provide the best healthcare outcomes with the greatest efficiency and at the lowest cost, and those companies that can cater to the needs of an aging population and the increasing economic empowerment of women around the world today, will be those that emerge as the most competitive companies of tomorrow. A number of companies within the healthcare, consumer and technology sectors should be beneficiaries of these themes.

5. THE EVOLUTION OF GLOBAL REAL ESTATE

“An often overlooked fact of the financial crisis of 2008 and 2009 is the global nature of the real estate market correction, for both residential and commercial real estate,” says Hyzy. “We think a recovery is under way, led by a well-entrenched residential recovery in the United States, positive long-term fundamentals for commercial real estate in emerging Asia, and the global reach for yield investments.”

“We have long thought of real estate as a guidepost for domestic economic cycles,” Hyzy continues. “But many of the factors that are important for growth in real estate demand and construction are secular in nature. Demographics and, more specifically, adult population growth, for example, form the basis for household formation. As we move deeper into a global real estate expansion, the secular macro tailwinds are a good starting point for sorting through potential long-term winners and losers.

“In the United States, a well-entrenched cyclical recovery characterized by falling unemployment and rising wages is now in place, and when this is combined with record-low inventories of existing homes along with new-home starts well below levels commanded by still-positive demographics, real estate investment should be in an upswing for years to come,” Hyzy says. “Commercial real estate should follow suit and may have the strongest upside potential at this stage. Outside the United States, emerging markets are increasing their market share in global commercial real estate, led by their growing middle class, positive demographics and relatively higher levels of growth. In Japan, the Bank of Japan’s long-awaited, aggressive reflationary efforts are a positive catalyst for real estate investments, often perceived as an inflation hedge.”

Investment Opportunities
The combination of healthy demographics, greater transparency, a growing consumer base and increasing crossborder capital flows suggests that the emerging markets will be an attractive area in which investors can seek commercial real estate opportunities over the next few years, according to U.S. Trust’s Investment Strategy Committee. A growing set of institutional-grade opportunities and an increase in securitization are reasons for continued optimism.

“We would specifically focus on the Asia-Pacific region,” says Hyzy, “but the U.S. commercial market also appears poised for growth. The domestic story (both residential and commercial) is positive not only for homebuilders, home improvement stores and building material providers, but for financial and consumer companies that should benefit as well. In Europe, opportunities to invest in distressed properties continue to develop.”

Riding the Tailwinds of Change
“These five major investment themes — and their numerous subthemes — are all propelled by the powerful and ongoing rebalancing of the global economy,” says Hyzy. “And they are by no means discrete. In many ways, they overlap and influence each other — sometimes positively, sometimes negatively. They touch multiple sectors and industries, and they will proceed at varying speeds as they develop. Together, though, they embody the major fundamental changes, the flux and evolution of the global economy in the next decade.

“At U.S. Trust, we believe these themes can help to provide us with the broad multi-industry context that we need to better understand the breadth of the economy’s changes. They help us to drill down more effectively into sectors, industries and individual investments, allowing us to avoid those areas and companies that are likely to be left behind so we can better position ourselves to benefit from the powerful tailwinds of change we expect to see in the years ahead.”

The Big Five Intersect

Technology and Economic Innovation + Emerging Market Middle-Class Consumers

The growth of a middle class in the emerging markets means rising demand, consumption and standards of living. And that means a growing appetite for all sorts of consumer-oriented technology, ranging from cell phones, wireless networks, computers and software to a myriad of tech-laden consumer products (cars, televisions, refrigerators, etc.). It also means greater demand for the technologies involved in the manufacture (robotics, the “near-sourcing” trend) and sale of these products, as well as for the big data analytics that firms serving this new market will need.

Technology and Economic Innovation + The Energy and Natural Resources Revolution

Over the years, advances in energy technologies have helped to diminish the problem of insufficient energy supplies, and they should continue to do so. The U.S. shale gas revolution is a prime example of technological advancement resulting in expanding energy production in spite of rapid depletion of conventional resources and often-obstructive governance. To satisfy future global energy demand and to produce energy from unconventional resources, large and sustained investment in energy technology and infrastructure is necessary in coming decades.

Technology and Economic Innovation + Geopolitics

The changing global demographic profile is a powerful long-term trend that, among other things, will have enormous implications on healthcare spending around the world. Countries with larger aging populations (such as the United States, Germany and Japan) will continue to be important for the healthcare markets, but growth opportunities reside elsewhere. Healthcare spending and investment will shift to the emerging markets, where the rising middle-class consumer is seeking an array of affordable, advanced medical products and services. Technological innovation and the standardization of data collection, recording and storage are desperately needed to tackle the inefficiencies and unsustainable costs that many countries face today.

Technology and Economic Innovation + Global Real Estate

Technological change may be the most powerful force shaping overall economic evolution, and the tech industry even plays a role, albeit an indirect one, in shaping real estate markets — both residential (those employed in areas experiencing tech booms) and commercial (manufacturing facilities, etc.). Technology even plays a role when it comes to the world’s fixed supply of farmland, where there is more and more pressure on yield-enhancing technologies to boost productivity.

Emerging Market Middle-Class Consumers + The Energy and Natural Resources Revolution

The rise of the emerging market middle class means rapidly expanding demand for energy and natural resources. The fact that 20% of the world’s population still has no access to electricity indicates considerable upside potential for global energy demand. In terms of natural resources, the rapid pace of global urbanization will place severe stress on water supply, sanitation, flood control and public transport systems. Potential conflicts over water resources would raise the cost of water and other commodities dependent on water for production — oil, natural gas, mining, etc. — and consumption (food).

Emerging Market Middle-Class Consumers + Geopolitics

In many ways, these themes are two sides of a coin. The rise of the emerging market middle class has implications for those companies seeking to meet the increasing demand for a wide variety of consumer products. At the same time, the overlapping demographic trends — a rapidly aging population in the developed world, a youthful population in the developing world — and rising income and living standards in the developing world speak to changes in spending habits. But they also speak to challenges, particularly in terms of healthcare, as serious health problems — such as obesity — tend to follow the rising urbanization, increased caloric intake and longer life expectancy that are the hallmarks of the consumer lifestyle.

Emerging Market Middle-Class Consumers + Global Real Estate

The rise of the emerging market middle class has clear implications for global real estate, particularly in Asia, where urban expansion and rising incomes are fueling demand for land, housing and commercial real estate. This same trend is affecting the supply-and-demand dynamics for food, and therefore farmland.

The Energy and Natural Resources Revolution + Geopolitics

Changing demographics, rising incomes and rapid urbanization in the developing world have triggered rising demand and higher prices for oil, corn, soybeans, copper and a variety of other commodities; these same dynamics have set off a global water crisis, and with it, a boom in water infrastructure spending.

The Energy and Natural Resources Revolution + Global Real Estate

Rapid urbanization throughout the emerging world, and the consequent demand for residential and commercial real estate and farmland (increasing demands for food), mean ever-growing demand for electricity and other natural resources such as water.

Geopolitics + Global Real Estate

Knowledge of a region’s demographic profile may play an outsize role in real estate markets. This is mainly because adult population growth tends to anchor household formation — a primary determinant of demand in domestic housing markets — but urbanization and immigration rates also matter. In much of the developed world, the size of households has generally been diminishing as birthrates decline. This is especially true in Europe and Japan.

Projections made may not come to pass due to market conditions and fluctuations.

Investing involves risk. There is always the potential of losing money when you invest in securities.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not assure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Stocks of small and mid cap companies pose special risks, including possible illiquidity and greater price volatility, than stocks of larger, more established companies.

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Commodities
Trading in commodities, such as gold, is speculative and can be extremely volatile. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest-rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Tangible assets can fluctuate with supply and demand, such as commodities, which are liquid investments unlike most other tangible investments.

Energy and natural resources stocks have been volatile. They may be affected by rising interest rates and inflation and can also be affected by factors such as natural events (for example, earthquakes or fires) and international politics.

Other
Nonfinancial assets, such as closely held businesses, real estate, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks, including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors.

Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties, such as rental defaults.