What the World Has Learned & What It Is Still Learning: A Global Forecast

1. What the World Has Learned& What It Is Still Learning:A Global Forecast Jay Taparia, CFA Managing Director, Sanskar Group of Companies Lecturer of Finance, University of Illinois @ Chicago Media Consultant, CFA Institute

2. About Jay Taparia, CFA • On behalf of CFA Institute, a public speaker / educator of business journalists on investments, financial statement analysis, and accounting tomfoolery since 2001. • Managing Director, Sanskar Group of Companies(Sanskar Investments, Sanskar Tax & Accounting, and Sanskar Insurance Services), Chicago, IL. • Former Senior Portfolio Manager, Bank One Investment Advisors (now called Chase). • Author of Understanding Financial Statements for Journalists (www.marionstreetpress.com or www.amazon.com). • Finance Lecturer, University of Illinois at Chicago, since 1999, in financial management, corporate finance, investments / personal finance, and international finance, and more recently new venture investing. • Contact Information: jtaparia@sanskar.com

3. What is a Forecast? • A forecast is simply an educated guess, but it is still a guess • We as analysts will always be wrong – so we might as well treat this as an art. • Being a number-cruncher may be a disadvantage. Having experience in “randomness” may be an advantage. Abstract thinkers like artists may actually be better employees than economists? • So there is no point to be part of a “consensus” if all of us are giving essentially the same number • Why is it that economists have failed to predict the last 7 of the 9 recessions (aka the key turning points)? • Fear of being different from the rest of the “consensus” and thus losing their job? • Econometric models may be “overused?” What do we need to do differently? • Why conform? Aesop’s Fables re: the Ant Colony

4. Where Should We Really Start? • Start from the Top, then Drill Down • The economy is made up of industries. • Industries are made up of companies. • Companies are made up of people. • So instead of watching statistics, why not watch people? We are generally more chaotic and definitely more interesting than “bird watching.” • We all love to watch “people,” right? The randomness and craziness of ourselves (i.e., validates Reality TV). • The Story of Husbands and Wives – Jay’s experience in Meeting with Private Clients and discovering who made the most investing mistakes.

5. Process Should Be What Now? • Instead of relying on one statistic, why not put several together to get a better conclusion? • Average age of Xbox User vs. Average Age of Marriage => Expected Age of Divorce? • Why believe too much in the numbers and have no life? When you can have a drink, mingle, get to make friends, and hear the real truth at a cocktail party (not just rumors, but new factoids from other people’s inebriations)

6. Blunt Statement on Analyst Forecasts • Hypocrisy between what we are taught (PV of cash flow) vs. what we see in reality (EPS and PE Ratios) to determine the value of the stock. • Analysts need to get rid of the expensive Italian suits, eating real food, and start sticking their hands in the dirt to get to the real truth (what was ever wrong anyway with playing in the sandbox?) • Conformity is our true disadvantage to our innovation and service to the customer. • I think we could look at the author Herman Hesse (his book called Siddhartha) on reflecting on his rebellion as a good example of what we really need to do more – question what we already know.

7. Our Agenda • The Big Picture – What Have We Learned • What We Still Have to Learn – Key Global Issues • Impact of Demographics • Natural Resource Supply and Demand • Technology and Science • The New Expensive Wars We Fight – Terrorism, Corporate Fraud and Financial Reporting Abuses • Changes in the Financial Services Industry - Beyond the Impacts of Key Global Issues

8. The Big Picture – What We Have LearnedThe Longest History of World Peace since WWII • We have experienced increases in personal wealth, rather than destruction (even literally) • Technological advances have modernized our lives,but also commoditizing itself and other industries (deflationary) • Large leaps in medicine/biotech and human longevity • The world has gotten closer – with cultural, language, and economic barriers lower – increased mobility, immigration, and trade • Higher efficiency of world financial marketsdue to electronic research, electronic funds transfer and electronic exchanges (i.e., technology)

9. Bottom Line – We prefer life (and advances in life) and are possessive of it – profit and happiness being key motivators! This is driving our future actions politically, economically, and socially This makes forecasting very easy.

10. Impact of Demographics • World population expected to increase to 7.2 billion by 2015 up from 6.1 billion currently - • Rate of population growth will have diminished from 1.7% annually in 1985 to 1.3 % today, to 1% in 2015. • More than 95% of increase in world population will be found in developing countries, nearly all in rapidly expanding urban areas (India, China…still) • The world’s population is becoming bipolar (no pun intended) – with emerging market populations on the rise while developed nations on the decline

11. Impacts on Various Markets • Emerging Markets - • In particular, Asia and Latin America • GDP will be strained or offset by such population growth • Countries will have to “innovate” or use “innovation” (technology leaps) to maximize existing resources • 50% of India’s population is < the age of 18 and has the highest rate of growth in IT professional graduates • Developed Markets – • Increased life expectancy, and falling fertility rates will contribute to a shift toward an aging population • GDP will be strained or offset by higher pension costs • Health and social systems will be pushed to the max (40% of costs attributable to 3% of patients in the US)

12. Identify Opportunities – Learning from Our Problems • Emerging Markets – • Have advantage to apply new technologies to maximize resources in urban areas • Have advantage to direct knowledge and technological resources to young population base in the areas of technology (India, China, Philippines) • Privatizations (if done properly) is the only way to unlock value and re-direct resources to fund growth – not always a well-received solution • Must upgrade Income and Capital Spending – Takes time and is LT. This becomes an investment criteria for looking at new opportunities. (Singapore, Inc.)

13. Identifying Opportunities – Learning from Our Problems • Developed Markets – • Strong GDP growth can be created by “youthful” demographics that have earnings potential. • 80% of the U.S. wealth is concentrated with 40% of the population age 50+(100 million Baby Boomers) • Worse age imbalances found in Europe and Japan • Longer life expectancies are straining Health, Welfare, and Retirement Systems (Florida often referred to as “God’s Waiting Room”) = Hospitals are considered seasonal. • Solution is via Immigration – the U.S., Canada, and Great Britain have grown LT technologically, and thus, economically via “importing” new perspectives and personalities – this has been key growth driver for the U.S. – 3.7% per year for past decade = sustainable growth

14. Natural Resource Demand • Sustained economic growth + population increases will drive nearly 50% increase in demand for energy over the next 15 years. • Total oil demand will increase from 75 MM barrels per day to more than 100 MM barrels per day by 2015 (equal to current production levels) • Natural gas will be key energy source of choice (growth of 100% by 2015) mainly stemming from tripling of gas consumption in Asia. • Asia will be key consumer of oil from the Middle East, while the West lessens its dependency (and hence, cyclicality in its economy)

15. Natural Resource Supply • 80% of world’s available oil still in ground • 95% of world’s natural gas also still in the ground • Renewable energy resources still expensive and still R&D - • Governments haven’t figured out how to subsidize development • Prone to cutbacks since R&D is a luxury expense outside of pension and interest costs • No change in use of nuclear energy usage – stays at current levels • We are still biased toward fossil fuels given easy access and lower cost

16. Identifying Opportunities –Learning from Our Problems • Suppliers will still have LT pricing power given availability and low cost • Urban areas will be key users of energy usage, especially from Asia • However, the new urban areas will be environmentally challenged • Pollution control not addressed for Emerging Markets – not interested in hindering growth via higher costs • Technology (fuel-cells and hybrid engines) will only reduce this concern as their costs decline. • Environmental (global warming) and health care costs are going to be backend-loaded.

17. Technology and Science • Technology is also making profitability in the tech sector almost non-existent – • Technologists are not financially-adept = they love just building things (Lucent / Bell Labs & phone innovation example) • Many thought that technology had its own secular trend and was not tied to the economic cycle – how so untrue! • Technology is a capital input as much as the typewriter or new manufacturing equipment. • Excess competition exists and hence, expect consolidation and a few large players to survive in the end

18. Opportunities in Technology Sectors • Wireless – saturated, but new technology life cycle • Telephony saturated – little growth • Data application is the new life cycle, however, adoption rates slower given that applications are not necessarily useful to average user • Small screens on phone and PDAs limit usability by mainstream • But wireless data applications are the key to the future when integrated with existing network systems. • In the U.S., where we suffer from “workaholism,” convergence is key with one machine having cell phone, PDA, broadband wireless email, and eventually some form of telepathy technology linked to the boss

19. Who Has Advantage? – The UserLearning from Our Problems • Technology User Gains > Technology Manufacturer Gains • The Technology Industry has shot itself in the foot with deflationary pricing power - • Extreme Competition ~ U.S. / European Football / Cricket • Moore’s Law – data density on a chip is still doubling every 18 months and will continue to do so until 2017 according to Moore himself

20. Who Has Disadvantage? – The UserLearning from Our Problems • Workaholism – “all work and no play” • Instead of freeing us, technology has “bound” us to work - Multitasking reduces our productivity and brain resources for processing (2 tasks ↓ 29%,3 tasks ↓ 53%) • Avg Vacation Days including Holidays = US = 13, Italy = 42, France = 36, Germany = 35, Britain = 28, Japan = 25 (has declined) • Surveys point out that getting 2 weeks of extra vacation more desirable than 2 weeks of extra pay • We in the US still have to learn that downtime means more productivity – despite our insatiable need to promote shareholder value – for now anti-depressants should continue to do well in future

21. Science Trends – The Demand • Demographics driving health costs, but industry not equipped • Large 50+ generation in developed nations driving future health care costs (historically viewed as “necessary evil“ by CEOs) • Bang for the buck higher in technology than in health care, especially during recessions – hence CEO reluctance • 16% of US GDP spent on medical care – within a decade this will be 25%! • Search for the “fountain of youth” by big Society = for now in the form of just looking younger and better looking • If you believe a little bit of Darwin’s Theory, this is deeply rooted in other mammals (female birds)

22. Science Trends – The Supply • Health Care Productivity Poor in general – • Grew at 0.7% from 1995-2000 vs. 2.6% annual rate for the rest of the U.S. economy • Imagine what this is like for socialistic, government-run systems! • An efficient industry and generally not receptive to software technology to improve quality of service • This is the only industry that added jobs in the last decade here in the U.S.

23. Science Trends – The Supply • In drug development, all “easy fruit” and “cosmetic drugs” have been picked – • We have become a very “Botox and Silicon” World • 50% of all patents expiring in next 5 years among big pharmas • Cancers, heart disease, gene therapies considered expensive R&D • Hence, consolidation and higher legal bills inevitable to maintain growth and prevent drugs from going generic so quickly • Big Pharma – all testing a new business model = merged entities

24. Science Trends – The Equilibrium • Health care costs are increasingly viewed as an “investment” - • Studies show society spends $1 on health care in the 1980s, and receives up to $2 of benefits • Treating low birthweight babies have added 12 years to life expectancy, producing net benefit to economy of $200,000 per child in the U.S. • U.S. spends $1 billion a year treating migraines – the opportunity cost is $13 billion annually in lost work days and reduced productivity • Age related illnesses (heart disease, strokes, arthritis, and back problems) already account for 20% of health care spending => This will only rise in the future for most developed nations

25. Opportunity in Science TrendsLearning from Our Problems • Health cost reduction found in Prevention and Detection - • Reducing high levels of obesity, smoking, alcoholism • Early diagnosis of diabetes and high blood pressure • R&D in the area of minimal invasive therapies – drastic reduction in heart treatments • General awareness to public that “health is truly wealth” – even in the areas of alternative medicine • Cost reductions also found via bias toward generic drugs - • Generic manufacturers stand to gain in the Long Term and not necessarily ST • They are branching into being “specialty” drugmakers to hedge legal battles with big pharmas – eventually they will have to work together – they need each other • Arbitrage opportunity still exists in buying drugs from overseas – not just Canada, but India, E. Asia as well.

26. The New Expensive Wars We Face -Global Terrorism • A total disregard for human life – • When it was normal to “win” if bad guys could lose out of fear of capture – now they have no fear • What the Greeks have coined a Pyrrhic Victory where both sides lose even if one side wins • Industries Impacted – • Expands the security industry (+) for the whole world given increased integration and global interaction • Insurance industry also impacted (-) with infinite (and still uncertain) amounts of premium to pay for extreme uncertainty. • The Sears Tower in Chicago noticed its insurance costs skyrocket by 50% post 9/11.

27. Tragedy and Pain… • Unfortunately, are ways we humans actually learn how to share and improve the way we do things – • 9 /11 and various ethnicities in World Trade Center • Iraq and the Middle East • I have personally built another 9/11 into my forecast – it is a new war we have to consider and you really cannot forecast this with an econometric model

28. The New Expensive Wars We Face – Financial Reporting Abuses & Governance • Recent survey by an executive research firm has extracted how that on average 40% of a CFOs time is spent looking for a new job • On average, auditors who bring up accounting issues and changes with management are refuted 40% of the time (in other words, they give in) • Who Wins with Higher Reporting Requirements and Sarbanes-Oxley? • Accountants themselves = higher salaries • Investors still have to learn financial statements – only then they will win.

29. So Where Do We Go From Here? As a the Finance Professional & Industry? As the Investor and the Stock / Bond Markets?

30. Impacts to the Developed Markets & Investors • Bonds are going to be a key asset class given demographic shifts in retirees and pension protection needs – the game with spreads will only get more complicated in under-standing the risk premia that go into it • Credit analysis is going to require in-depth knowledge of off-balance sheet debt and pension accounting (currently bond traders only quote debt ratios based on ON-balance sheet debt, not OFF) • Information flow is burgeoning and with higher speed of dissemination – expected higher volatility across all markets and asset classes • Large market booms hardly likely in the future, but will exist in the form of style fads (like the evolving flair / bell-bottom pants)

31. Impact to the Finance Professional • Knowledge is power – higher need for continuing education • We must practice “voracious reading” – but not just on company financials and industry trends • As an individual advisor – Ican truly say the demand for knowledge in both financial planning / structuring and product is high. • Additional Education Needs of the Financial Professional or CFA Charterholder • Financial Planning • Tax Rules and Tax Law, including Estate Planning • Life, Health, LTC, Disability Insurance and how it impacts Assets under Management

32. Impact to the Financial Services Profession • According to a survey in 2002, 1/5th of millionaire investors around the world are working without a financial advisor and increase of 30% over 2001. • Mostly of sample working with full-service brokerage firms and increasingly dissatisfied • Brokers got a D grade, Financial Planners got a B grade • 23% of millionaire households now use planners instead of brokers up from 14% in 2000. • There are 3x the number of advisors chasing after the $3 million + net worth population

33. Impact to the Financial Services Profession • Bottom Line? – The marketing phrase “wealth management is a joke” without continuing education. • We are still plain Jane asset managers and are not equipped to give a larger realm of advice to our clients. • Clients will still be left “confused” on conflicting information from many different providers and thus will not feel “trust.” • Something well known to us if they make movies like “The Boiler Room” and “Wall Street” on our industry

34. Thank You!