Economic Outlook 2012.

01

2012: A Year of Bargaining Equities

ALKHABEER GLOBAL ECONOMIC OUTLOOK 2012.01

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Economic Outlook 2012.01

DISCLAIMER

This document is issued by Alkhabeer Capital and it is intended for general information purposes only, and does not constitute an offer to buy or subscribe or participate in any security, nor shall it (or any part of it) form the basis of or be relied on in connection with or act as inducement to enter into any contract whatsoever. This document is confidential in nature and is only intended for selected sophisticated investors. If you have mistakenly received this document, you are hereby requested to disregard its contents and return it to Alkhabeer Capital or destroy it. Alkhabeer Capital shall not be liable for any loss that may arise from the use of this document or its contents or otherwise arising in connection therewith. Alkhabeer Capital, its affiliates or funds managed by Alkhabeer Capital or its affiliates may own securities or may be involved in advisory mandates in one or more of the aforementioned companies. Any projections, opinion, and statements regarding future prospects contained in this document may not be realized. All projections, opinions and statements included in this document constitute opinions of Alkhabeer Capital as of the date of this document, and are subject to change without notice. Any type of past performance cannot be construed as a guarantee of future results. The value, price and income from securities can go down as well as up. Investors may get back less than what they originally invested. Changes in currency rates may have an adverse effect on the value, price or income of the securities. For an illiquid security, it may be difficult for the investor to sell or realize the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. The Capital Market Authority does not take any responsibility for the contents of this document, does not make any representation as to its accuracy or completeness and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document.

For Further Information: Khurram Shehzad, CFA [email protected] Alkhabeer Capital P.O. Box 128289 Jeddah 21362 Kingdom of Saudi Arabia Tel.:+966-2 658 8888 Fax:+966-2 658 6663 CR No: 4030177445 CMA Licence No: 07074-37 www.alkhabeer.com

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Economic Outlook 2012.01

2012: Outlook Summary

Global growth: Unlikely to exceed 2.5%
Europe is expected to shrink by 0.6%, USA unlikely to post higher than 1.5% growth and the Emerging world likely to post 5.1% growth; the global economic growth is expected to close around 2.5% for the year 2012, wherein China may contribute more than 40% of total global economic growth.

2012: Year of bargain hunting in equities

After reviewing all the asset classes and taking into account our economic growth estimates, we come to the conclusion that in 2012, bargain hunting in equities is likely to generate the most optimum return depending on the investors appetite for risk.

Global equities: Likely to surge up to 26%

Globally, the PE ratio is expected to approach its 10-Year mean and could generate capital gains potential of up to 26% in equities.

Commodities: Flat to negative performance

Slower growth in consumption, higher growth in supply and lesser depreciation in the value of currencies suggest medium to long term outlook for commodities: flat to negative.

Oil Prices: Expected to decline by 5%

Based upon additional supplies, 2% appreciation in US dollar and slowdown in global consumption growth we expect oil prices to shrink by 5% in 2012.

Saudi Arabia: Expected to grow 4.6%

Growth is mainly derived from an expected jump of 16% in budgetary development spending in 2012 as an outcome of USD 133 billion economic stimulus package announced by the government of Saudi Arabia.

Saudi real estate: Very limited upside potential

Although demand in residential segment is high but higher land prices restrict development potential, whereas Saudi inflation expectations and lower oil prices are likely to cause limited price increase in the Saudi real estate sector.

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Economic Outlook 2012.01

Table of Contents

GLOBAL ECONOMIC GROWTH TRENDS Developed world Emerging world Frontier world Saudi Arabia GCC

1 2 3 4 4 5

ASSET CLASS VALUATION OUTLOOK Commodities Oil price Real estate market Saudi Arabia real estate market Fixed Income market Global equities market Saudi Arabia equities market

5 7 8 9 10 11 12 13

CONCLUSION

14

APPENDICES Appendix A Countries Classification Appendix B Data Sources 15 16

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Economic Outlook 2012.01

Global Economic Growth Trends

Growth, in an economy or a business is a combination of three ingredients money (Finances), people (Expertise) and ideas (Intellect). It is necessary that any investment recommendation follows expectations of the overall economic growth. We believe that even in a recessionary world there are countries which will continue to grow and we have employed in-house proprietary models to identify them.

140% 120% 100% 80% 60% 40% 20% 0% -20% 10 Year Growth in GDP-PPP Developed World 10 Year Relative Growth in Total (public+private) Debt Frontier World

Emerging World

Conventional economic tools: Less effective

In terms of GDP-PPP per capita , the Developed world still contributes 62%, followed by the Emerging2 world (22%), Frontier2 world (13%) and underdeveloped world (3%). Over the last ten years the Developed world provided technology, the Emerging world manufactured while the Frontier world provided raw material. Simultaneously, Developed world leverage rose, neutralizing the cost benefits of technology. However, the trough of this cycle coincided with economic recession leaving conventional economic tools less effective.
1 2

Source: IMF World Economic Outlook; World Bank Development Indicators

6% 4% 2% 0% -2% -4% -6% 10 Year Relative Growth in Services Sector GDP Developed World Emerging World Frontier World

Shorter growth Cycles

Almost 40% of Developed worlds GDP and 25% of global GDP is contributed by USA. Therefore, economic growth trends in USA are going to affect the entire world. Total debt (Public + Private) to GDP for USA is 3xs and for the entire world it has reached 1.91xs, which is the highest in history. Such high debt levels reduce the growth capabilities of the corporate sector and the governments firepower to induce growth. Therefore, future economic cycles are expected to be shorter in time horizon.

Source: IMF World Economic Outlook; World Bank Development Indicators

1. 2.

Gross Domestic Product Purchasing Power Parity / Total population For the list of countries categorized as Developed, Emerging and Frontier please refer to Appendix A

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Developed World
90%

8% United States 6% 4% 2%

US: Growth is expected to be less than 1.5%

US economic growth is unlikely to exceed 1.5% for 2012, mainly because 86% of the growth is driven by domestic consumption, which has limited upside potential with high debt levels. A growth cycle is expected from 2013 based on technological gains but is likely to be short i.e. 24 months. Post 2014, a lot depends upon how the US government tackles unfunded liability of USD 114.5 trillion (as per the data from Federal Reserve, total US unfunded liability to be paid from 2015 to 2027 and it includes social security, prescription drugs and Medicare part D) because that factor alone could make growth impossible after 2015.

89% 88% 87% 86%

0% 2002 -2% -4% GDP-PPP Growth

Source: IMF World Economic Outlook

2003

2004

2005

2006

2007

2008

2009

2010

85% 84% 83%

EU: Expected to contract by 0.6%

2012 will be extremely challenging for Europe but 25%-30% devaluation of the Euro against USD is a likely outcome, as the European Central Bank (ECB) print its way out of USD 1.8 trillion total (public + private) troubled debt of Portugal, Ireland, Greece and Spain (PIGS). We believe that Italys economic situation is better than PIGS. This fiscal tightening in PIGS and its spillover effect on other EU countries is expected to result in a 0.6% contraction in EU GDP for 2012. After devaluation EU will encounter an extra volatile phase (2013), which may be followed by a growth normalization phase.

Relative Domestic Consumption

Norway Country Profile

GDP-PPP / Capita (USD) Total debt (public + private) as % of GDP Total Savings as % of GDP Total Investment as % of GDP Fixed capital formation as % of Investments Human Development Index Global Competitiveness Index 51,960 150% 34% 21% 111% 0.94/1 5.18/6

Rank Among Developed

2 4 2 8 1 1 14

Norway: Best amongst Developed; Expected currency gains 20%

The entire Developed world is unlikely to grow by more than 1% in 2012, and Norway is expected to be the best performing economy for 2012 based upon our research. Norway boasts a balanced growth model with only 60% reliance on domestic consumption compared to an average of 72% for the entire Developed world. In addition to that its total debt to GDP is 150% compared to the Developed world average of 285%. The key benefit lies in the currency of Norway i.e. Norwegian Krone, which is likely to translate the full benefit of Euro depreciation, unlike the US Dollar (USD). In 2012, we expect the Norwegian Krone to appreciate by upto 20% against Euro. Current GDP contribution of Developed world (55%) is likely to shrink to less than 50% by the end of 2013. Simultaneously, a few central Asian states like Uzbekistan may find themselves in the Frontier world along with same African states including South Sudan. Investments in such countries offer significant returns with higher political risks.

Source: IMF World Economic Outlook; World Bank World Development Indicators; UNDP Human Development Report; World Economic Forum

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Emerging World
China: Soft landing but 24% reduction in growth
The Chinese economy today is approximately 11% of total world economy (2nd largest) and its sovereign reserves exceed USD 3.2 trillion; therefore, a clear view on Chinese economic trends is necessary. In fact, only in Q3 2011 the Chinese economic growth contributed almost 38% of the total world growth, so growth in China defines the global trends. China faces four key challenges: 1. Maintaining inflation below 3%; 2. To curtail real estate prices thereby reducing savings (Chinese save in real estate) and stimulate domestic consumption of exportable surplus; 3. Managing soft landing for USD 1 trillion troubled local government debt; and 4. Exchange rate policy which supports internal as well as external challenges. From its peak of 6.5% (Jul-2011) inflation has come down to 4.2% (Nov-2011). Real estate prices have been shrinking by almost 35bps cumulatively since Oct-2011. The currency has appreciated by almost 15% during the last ten years against the USD. Banking reserve ratio (21%) can inject liquidity of USD 1.1 trillion, if cut to 10%, which can mitigate the liquidity crunch arising out of the local government debt write-offs. However, all of these measures and the growth slowdown in Developed world are expected to reduce the Chinese GDP growth to 6.9% in 2012.
3

200 Money Supply to GDP 150

100

50

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 USA China

Source: IMF World Economic Outlook

10.00 8.00 6.00 4.00 2.00 0.00 -2.00 -4.00 -6.00 Emerging World
Source: Trading Economics

Post 2008 Crash Growth

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2009 2009 2009 2009 2010 2010 2010 2010 2011 2011 2011

Emerging world: Expected to grow by 5.1%

Within the Emerging World after China (40%), India (15%), Russia (9%) and Brazil (8%) are the biggest emerging economies. Indian economic model will be affected by the slowdown in services demand from the Developed world and GDP growth may reduce to 6% from 7.5%. Russia and Brazil are commodity economies and because of our flat outlook for commodities in 2012, growth in these two economies is likely to stagnate around Q4 2011 levels. The Emerging world growth may slow down to 5.1% in 2012 i.e. a 17% reduction YoY.
3. According to Moodys estimate Chinas local government debt is USD 2.2 trillion; 78% is lent by local banks. Standard Chartered Bank estimates 56% of this debt could go bad so the banks may write-off approximately USD 1 trillion

Developed World

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Frontier World
Rank Among Emerging

Qatar Country Profile

GDP-PPP / Capita (USD) Total debt (public + private) as % of GDP Total Savings as % of GDP Total Investment as % of GDP Fixed capital formation as % of Investments Human Development Index Global Competitiveness Index 88,222 82% 56% 30% 108% 0.83/1 5.24/6

Qatar: Expected to grow by 7%

Amongst the emerging economies, Qatar tops our list based upon our proprietary models. GDP is expected to grow by 7% in 2012 on the back of new government owned industries coming online. Although gas prices have fallen sharply (18% in Q4-2011) but even after accounting for that with utmost conservative assumptions Qatari growth does not seem to slide below 7% level in 2012. With 82% total debt to GDP and 35% domestic consumption, the economy stands on strong footing.

1 5 1 5 7 2 1

Frontier economies: Expected to grow by 3.4%

Frontier economies are 6% of total nominal global GDP and almost all of the countries are commodity producers. Therefore, based on a flat outlook for commodities we only expect growth which is driven by domestic investment and consumption. In 2012 total expected growth in Frontier economies is expected to be 3.4%, which is a 12% reduction from their 2011 growth levels. However, due to the prevailing challenges in Developed and Emerging economies the Frontier world is likely to experience highest impact of FDI, as measured by FDI/GDP ratio.

Source: IMF World Economic Outlook; World Bank World Development Indicators; UNDP Human Development Report; World Economic Forum

180 160 140 120 100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Current Account Surplus (USD Billion)
Source: IMF World Economic Outlook

14.00% Saudi Arabia 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%

Saudi Arabia: Best frontier economy; expected to grow 4.6%

Saudi Arabia emerges to be the best Frontier economy based upon our proprietary models. With a lower debt profile (total debt 58% of GDP), higher investment (23% of GDP) and rising infrastructure spending, the country is expected to grow by 4.6% in 2012. This growth of 4.6% is mainly derived from an expected jump of 16% in budgetary development spending in 2012 as an outcome of USD 133 billion economic stimulus package announced by the government. Primarily an oil based economy, our assumption for Arabian crude for 2012 has taken into account a 5% decline along with a 2% appreciation for USD.

Saudi Arabia: USD peg to stay and 4.1% inflation

Like any Frontier economy, common investor concerns are currency movement and inflation. In this regard, Saudi Arabia is unique because of its peg with the USD and 95% oil contribution towards government revenues. Therefore, monetary measures-money supply-is used to balance imported inflation. Based upon our oil price outlook and past Saudi Central Bank measures we conclude that 2012 inflation is unlikely to exceed 4.1%.

GDP-PPP Growth

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GCC
2012 Expected growth 4.60% 3.00% 2.70% 1.20% 2.40% 7.00% Growth contribution 2.27% 0.33% 0.16% 0.03% 0.47% 0.83% 4.08%

GDP (USD Billion) Saudi Arabia Kuwait Oman Bahrain UAE Qatar TOTAL 623 139 76 30 248 150 1,266

Share 49% 11% 6% 2% 20% 12% 100%

GCC: Expected to grow by 4.1% amidst low inflation The GCC region is expected to register GDP growth in excess of 4% where Qatar will top the list followed by Saudi Arabia, Kuwait (3%), Oman (2.7%), UAE (2.4%) and Bahrain (1.2%). At the same time, regional inflation is also expected to drop by more than 20% as commodities and global growth flattens during 2012.

Source: Alkhabeer Capital estimates

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Economic Outlook 2012.01

Asset Class Valuations

Any asset class pricing is a function of demand and supply, wherein we have identified the most significant factors for each asset class below: Demand Commodities4 Fixed Income Instruments4 Real Estate4
Consumption

450 400 350 300 250 200 150 100 50 -

Asset Class Performance Fixed Income Instruments Commodities Realestate Non-nancial Equities

Supply Non-Services GDP Debt creation Limited Real growth

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Bloomberg

Volatility in returns Easy money Technology

Equities4

Subsequently, we apply in-house proprietary models to deconstruct the previous returns and based upon that we forecast future asset class expectations.

4.

Fixed Income Instruments (S&P/CITIGROUP INTL TREASURY BOND INDEX), Commodities (S&P WORLD COMMODITY INDEX), Real Estate (S&P GLOBAL PROPERTY INDEX) and Equities (FTSE NON FINANCIALS INDEX)

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25000 Commodity Price Story

Commodities: Flat to negative performance Over the last ten years, Consumption5 grew by 69%, Supply6 grew by 35% and Global fiscal deficit7 increased by 344%. As a result, deficit financing and non-wage inflation shot up while long term currency value went down. All of these factors caused Commodities to increase by 317%.
Going forward, we believe that global total debt to GDP ratio will not exceed 2xs, which currently stands at 1.91xs. We believe that another round of massive debt creation is unlikely because debt costs are already at their historic lows so further debt creation would require an upwards push in rates. Increase in debt costs would lead to massive deficits and a vicious cycle due to the high current debt levels. Simultaneously, the austerity measures to be adopted by the Developed world are eventually going to restrict consumption led growth and drive the sustainable corporate profitability led growth. At the same time higher investments in commodity providers (mainly Frontier economies) are likely to enhance supply. Slower consumption growth, higher supply growth and limited depreciation in long term currency value keep the medium to long term outlook for commodities flat to negative. However, the current debt levels are 1.91xs and may go up to 2xs. This small window is at a critical threshold point and this is expected to cause volatility in commodities at least for 2012. We believe that commodities may have a volatile 2012 but on a closing basis they are expected to post flat to negative performance.
5. 6. 7. Global domestic consumption / Total population Non-services GDP-PPP / Total population Global fiscal deficit / GDP-PPP

20000

15000

10000

5000

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Per Capita Money Supply (USD) Per Capita Consumption (USD) Non-Services sector GDP-PPP Per Capita Total Debt (USD)

Source: IMF World Economic Outlook; World Bank World Development Indicators

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Economic Outlook 2012.01

90 88 86 84 82 80 78 76 74 72

Crude Consumption (Mn. Barrels) Crude Price (USD/Barrel)

120 100 80 60 40 20 0

Oil Prices: Expected to decline by 5% Oil price is affected by three factors: (1) Demand and Supply; (2) Political developments; and (3) Currency outlook.
Global oil (WTI) Demand
It is 87 Million Barrels Per Day (MBPD), supply is 88.3 MBPD and 2012 oil demand is expected around 89 MBPD. As the oil price crosses the USD 115 / barrel, it approaches USD 4 per gallon (psychological point). As a result consumers reduce fuel consumption, spending shrinks and demand goes down. Therefore, currently USD 115 / barrel is a price cap.

Additional global oil supply can be obtained from:

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: US Energy Information Administration; Bloomberg

(A) Non-utilized production capacity; (B) Proven reserves; (C) New discoveries; and (D) Strategic reserves. For non-utilized production capacity: (a) Iraq production increasing by up to 2 MBPD by the end of 2012; (b) Libyan production being restored; and (c) Saudi additional capacity of up to 2 MBPD are the three most significant short term supply factors. For proven reserves: (a) North American shale oil reserves; and (b) South American discoveries are the two most important medium term supply factors. Price movements affect new discoveries because at prices below USD 90/barrel economic feasibility of oil exploration is affected negatively hence prices increase. Thus, currently USD 90 / barrel is a price floor.

Political developments

Sanctions on Iran can squeeze supply of up to 2.7 MPBD. Major buyers of Iranian oil are China, Turkey, Italy, Spain and Greece. None of them accepted the new sanctions on Iran. In fact, Italy, Spain and Greece asked for a 6 month period to arrange the alternates. Therefore, at least, in the next 6 months Iranian supply is unlikely to be taken out. Even if sanctions are imposed on Iran then the supply gap can be covered by non-utilized production capacity.

Currency outlook

We expect US Dollar to appreciate by up to 2% against six (6) major currencies mainly because of expected Euro depreciation (25%), Yen appreciation (10%) and Yuan appreciation (3%).

We believe, based on these factors and our analysis, that oil prices are expected to decline by up to 5% in 2012.
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Economic Outlook 2012.01

120 Real Estate & USA Leverage 100

300

Real estate: Bargain hunt selectively

In the real estate sector global historic data is either not available or does not stand the rigors of stress testing. Therefore, we have used US real estate as a proxy for global trends. The Real Estate returns from 1978 to 2004 averaged around 8% p.a. whereas during 2004 - 2011 period, Real Estate returned 3% p.a. At the same time, demand and supply imply last decade to be a good period for Real Estate. But actually Real Estate produced returns less than the 26 year average mentioned above. The corporate debt created as a result of easy money policy, fueled a Real Estate boom (163% increase from 2002-2006) and was transferred to Wall Street through instruments which used real estate as the underlying security. In order to support high levels of debt, high valuations were undertaken. However, eventually, valuations reflected the ground reality and Wall Street debt was transferred to the US Government (via the 2008 bailout). In this entire process the short to medium term price appreciation potential of the sector was severely affected. Furthermore, unsustainability of easy money policy only confirms that price appreciation potential in the sector is limited to 6%-7% annually. However, selective bargain hunting in certain types of real estate across the globe can yield significant returns. In order to select the real estate market which could offer good returns, we rely upon our in-house research and proprietary models.
8

250

80

200

60

150

40

100

20

50

2000

2007

2011

Corporate leverage (S&P500 es-Financial Net Debt/Assets) Wall Street leverage (Average Assets/Equity for Goldman Sachs & Morgan Stanley) Government leverage (Public sector debt/GDP-Nominal) Real Estate
Source: KKR Insights Global Macro Trends - October 2011; Bloomberg and S&P

Bargain hunt in Austrian, French, Indonesian, Peruvian and Saudi markets

Amongst the Developed world Austria and France, amongst the Emerging world Indonesia and Peru, and within Frontier world Saudi Arabia offers real estate gains potential on selective basis.

8.

Study by Jack Clark Francis, a finance and economics professor at Baruch College in New York City, and Yales Roger G. Ibbotson

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Economic Outlook 2012.01

1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1H2009 (SAR 000s)

Saudi real estate: Demand supply gap

Saudi Residential Real estate

According to data from KSA Ministry of Economic and Plannings eighth development plan (2005-09) Saudi Arabia at the end of 2009 had a total housing stock of 4.6 million units and a demand supply gap of 0.4 million units. We estimate that by the end of 2011 this gap has further risen to 0.47 million units and by 2015 it is expected to reach 1 million units. On the other hand commercial and retail segments are experiencing over-supply scenario.

Saudi real estate: Sustainable demand

Demographics and urbanization are the two most significant factors which drive the residential demand in KSA. Almost 20% of the population is aged between 15 and 25 years, which will create housing demand over the next ten years. Moreover, according to data available from SAMA and CDSI between 1985 and 2010 the urban population as a percentage of total population has risen from 73% to 82%.

2H2009

1H2010

2H2010

1H2011

Riyadh (Asking sale price for 300-400 sqm Villa) Jeddah (Asking sale price for 300-400 sqm Villa) Dammam (Asking sale price for 300-400 sqm Villa) Khobar (Asking sale price for 300-400 sqm Villa) Dahran (Asking sale price for 300-400 sqm Villa)

Riyadh (Asking sale price for 135-190 sqm Apartment) Jeddah (Asking sale price for 135-190 sqm Apartment) Dammam (Asking sale price for 135-190 sqm Apartment) Khobar (Asking sale price for 135-190 sqm Apartment) Dahran (Asking sale price for 135-190 sqm Apartment)

Source: Banque Saudi Fransi Real Estate Saudi Arabia Report May 2011

7000 6000 5000 4000 3000 2000 1000 0 H2 2008 Riyadh

Median price per sq m

Saudi real estate: Very limited upside potential

Saudi Arabia Commercial Real Estate

In Saudi Arabia real estate is actively used for speculation through raw land deals. Unfortunately, the capital accumulated over the past ten years due to oil prices has been put into real estate mainly. Hence the prices have become artificially high and this mispricing restricts the land development potential although demand for residential segment is high. The only way out is if government puts a time limit on owning raw land, then the land owners will be forced to develop the land along with boosting related industries. In view of the flatter oil prices going forward and lower Saudi inflation, we do not expect significant price appreciation, which arise out of wealth creation.
H1 2011

H1 2009 H2 2009 H1 2010 Jeddah Makkah

H2 2010

Source: Banque Saudi Fransi Real Estate Saudi Arabia Report May 2011

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Economic Outlook 2012.01

160 140 120 100 80 60 40 20 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: IMF World Economic Outlook; World Bank World Development Indicators

2.50 Global GDP-PPP (USD Trillion) Global total debt (public+private) (USD Trillion) Global total debt to GDP

Fixed Income: Selectively pick distressed sovereign issues As the governments, especially US, maintained easy money policy and issued debt, global total debt to GDP rose from 1.45xs to 1.91xs during 2000-2011, it created a supply of fixed income instruments while the volatility in different asset classes created their demand.
However, the loss in long term currency value did not increase yields on fixed income instruments, rather they fell down as Fixed Income Instruments (SRP/CITI GROUP INTL TREASURY BOND INDEX) increased in prices by 120% during the last ten years. At the same time the non-wage inflation also picked up but did not lead to an increase in yields on fixed income instruments. The impact of long term currency value depreciation is mitigated by the productivity gains achieved through technological advances during the last ten years. Moreover, if unemployment is accounted for along with average wage per person then, in real terms, overall wage deflation occured and that mitigated the impact of non-wage inflation. We believe that fixed income instruments issued by stronger sovereigns should be avoided as their prices are expected to decline, whereas fixed income instruments issued by weaker sovereigns are likely to offer better capital gains potential though with a higher risk. In order to identify the sovereigns whose instruments could offer good returns, we use our in-house proprietary models.

2.00

1.50

1.00

0.50

0.00

Time the Italian, Spanish, Hungarian and Brazilian instruments

Amongst the Developed world, instruments issued by Spain and Italy may prove to be winners in terms of capital gains but with high risk as the economic health of these economies is not terminally fated. Within the Emerging world instruments issued by Hungary and Brazil can bring in windfall gains as investors correctly value the sustainable economic models of these countries. 2012. All rights Alkhabeer Capital. Confidential 11

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7.00 Dividend Yield V/S Bond Yield 6.00 5.00 4.00 3.00 2.00 1.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 S&P500 Dividend Yield
Source: Trading Economics; Reuters

Global equities are likely to surge up to 26% The S&P500 returned 13% p.a. during 1990-2000, whereas during the last ten years it has returned only 0.91% p.a. Although technology created demand for Equities but absence of real economic growth impeded the supply.
During the last decade corporate profitability increased along with non-wage inflation, which suggest that equities should have performed well. However, the actual equity performance was quite dismal as mentioned above due to a number of reasons. Firstly, the average wage remained flat but the rising unemployment actually reduced the aggregate wage pool. Secondly, this reduction in aggregate wage pool was the primary reason for increased corporate profitability instead of real economic growth. Reduction in aggregate wage pool increases medium term corporate profitability but at the same time it decreases long term corporate profitability prospects due to long term demand reduction. Therefore, medium term increase in corporate profitability was cancelled out by long term decrease and equities generated flat performance. S&P500 is a good indicator of global equity trends as the cross border business interests have 9 grown over time. When S&P500 yielded a dividend of 1.16% UST-10Y yielded 6%. Today UST-10Y yields 2% while the S&P500 yields a dividend of 2.53%. With a worst case scenario of 10% drop in corporate earnings, the dividend yield drops to 2.2%. This only confirms that equity valuations are at one of the lowest levels as the global PE ratio is also 26% below its 10-Year mean. Going forward lack of returns in commodities, fixed income instruments and real estate will convince investors to have a fresher look at equities. In addition to that we believe that dividend yield will come down to 2.0%, which puts the S&P500 price appreciation potential at 18%. Globally, the PE ratio is expected to approach its 10-Year mean and may generate capital gains of up to 26% in equities. We have relied upon our in-house proprietary models to identify the best equity markets for return generation in 2012.
9. United States Treasury Bond of 10 Year maturity

UST-10Y Yield

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Economic Outlook 2012.01

40 35 30 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Global Price to Eamings ratio (xs)
Source: World Federation of Exchanges; Reuters

4.00 Global Equities Valuation 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00

UK equities: Best amongst Developed world

Trading at a PE of 10.5 and yielding 3% dividend, UK equities are likely to be the best pick amongst the Developed world with a price appreciation potential of up to 30%.

Russian equities: Highest growth potential

Trading at a PE of 9.5 and yielding 2% dividend, Russian equities are expected to be the best pick amongst Emerging world with a price appreciation potential of 32%.

Saudi equities: Good returns with modest risk

Trading at a PE of 11.5 and yielding 3% dividend, Saudi equities are the best pick amongst Frontier world with a price appreciation potential of 17%. Based on our global growth expectations, we believe that sectors which are domestically focussed such as Cement, Food and Retail are likely to be outperformers this year. Amongst GCC countries, we only recommend high dividend Kuwaiti stocks, selected equities in Omani hospitality & logistics sector and Qatari equities.

Global Dividend Yield (%)

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Economic Outlook 2012.01

In conclusion
Going forward, selective returns in real estate and fixed income instruments along with historic low valuations in equities make a very strong argument in favor of equities. The availability of liquidity and ease of investment make equities even more attractive for investors who find themselves with limited options in other asset classes. According to our research based conclusions, we believe that the most suitable asset class for investors in 2012 will be equities depending upon the respective risk appetite. The only aspect we emphasize with respect to equities is the significance of bargaining due to volatile nature of this asset class compared to real estate and fixed income instruments. Depending upon the investors appetite for risk the timing of entry and exit can be determined to increase returns in equities as compared to a simple Buy and Hold strategy.

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Economic Outlook 2012.01

APPENDIX A

List of countries by category

We have used the S&P classification of countries, barring three exceptions, which are as follows: 1. Countries which do not fall in Developed, Emerging and Frontier category are classified as Underdeveloped. 2. As per the practice defined in (1) above, Saudi Arabia should fall in Underdeveloped category; however, we have included Saudi Arabia as a Frontier market due to upgrade potential 3. Qatar and United Arab Emirates are included in the Emerging world instead of Frontier due to their upgrade potential.
Underdeveloped world

Developed world 1 2 3 4 5 6 7 8 9 10 11 12 13 United States United Kingdom Australia Austria Belgium Canada Denmark Finland France Germany Greece Hong Kong Ireland

Emerging world Brazil Chile China Czech Republic Egypt Hungary India Indonesia Malaysia Mexico Morocco Peru Philippines

Frontier world Argentina Bahrain Bangladesh Colombia Kenya Kuwait Nigeria Oman Pakistan Romania Saudi Arabia Sri Lanka Ukraine

Underdeveloped world Algeria Ethiopia Iran Iraq Sudan Syria Tanzania Thailand Uganda Uzbekistan 14 15 16 17 18 19 20 21 22 23 24 25

Developed world Occupied Palestine Italy Japan Netherlands New Zealand Norway Portugal Singapore South Korea Spain Sweden Switzerland

Emerging world Poland Qatar Russia South Africa Turkey UAE

Frontier world Venezuela Vietnam

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Economic Outlook 2012.01

APPENDIX B

Data Sources
Data sources used for our proprietary models and reports are as follows: 1. IMF World Economic Outlook 2. World Bank World Development Indicators 3. Bloomberg 4. Reuters 5. United Nations Department of Economic & Social Affairs 6. Transparency International 7. CIA Fact book 8. Global Competitiveness Report by World Economic Forum 9. 2010 Human Development Report by United Nations Development Program 10. 2011 EFA Global Monitoring Report by UNESCO 11. Economic Intelligence Unit 12. Zawya Investor Services 13. UBS Price and Earnings Report 14. TradingEconomics 15. World Federation of Exchanges

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