US Employment data is robust

In Chapter 3 (Article 9) I focused on the key US economic release which appears at the start of each new month. This is the data on employment which is always published on the first Friday. Last week's data showed  that the US economy added an additional 163,000 new jobs in July. However, the same release showed a rise in unemployment from 8.2% to 8.3%. This latest economic release was generally more robust than had been expected. In the article I explain just why this is such a key factor for financial markets. Put simply the data has an enormous impact on the economic policy-makers in the US. Most significant changes in the Federal Reserve's interest rates can be linked to what happens to employment levels in the economy. The data is also reliable and very timely. You should try to get used to following the various economic data releases as they appear each month. As a starting point look out for the build-up to the next Employment release on the first Friday in September.

Getting ready for a finance or legal internship interview

I know this is an important time for many students facing interviews for various financial and legal internship schemes. It can be a worrying time as you are trying to impress an interview panel in order to secure one of the very few opportunities to get useful and relevant summer work programmes with an investment bank or a leading UK law firm. I know from some emails I have received that this book is often used to help prepare for this process. This year I would like to advise you on using the book for this purpose. So the next couple of blogs are designed to help you!

1) If you have little knowledge of finance and economics the book can really help you get the basic knowledge. You should focus first on the introductions to each Topic. These are short overviews of most of the key corporate finance topics. They should easy to read and they will help you to get a quick overview of the subject. I would start with Topic 2 (Financial Institutions) and Topic 3 (Financial Markets). Once you have this framework covered you can work your way through them one by one.

2) The interviewers will expect you to know what the key terms mean. Use the glossary to understand things like LIBOR, FT-SE 100, repos, Bullish, Bearish etc.

3) The Merger and Acquisition topic is popular with the law firms. So make sure you read through this carefully and find out as much as possible from the FT on current deals.

I hope this helps...

All the best and good luck

Kevin

Central Banks act to prevent second credit crisis!

Yesterday saw dramatic moves being taken by the major Central Banks in an effort to prevent a second serious round of the credit crisis. In this action the Fed was joined by other major central banks in moves to enable foreign banks to be able to borrow and lend money more easily. This was designed to stop an imminent breakdown in global financial markets a the Eurozone continues to deal with the debt crisis. In this new round of central bank intervention we saw the expansion of the Fed program which allows foreign banks to borrow dollars cheaply. This will hopefully allow these banks to provide the finance to companies which is crucial if we are going to see any signs of stronger economic activity. The actions of the normal Central banks (Fed, ECB and Bank of England) was also helped by some independent moves by the Chinese central bank which took action to encourage new lending by their commercial banking system. The reaction of the stock markets was very positive with many stock indexes soaring in value. The German DAX index rose by 5 percent and the US S & P 500-stock index jumped more than 4 percent. While these moves were welcome it should be stated that the actions of the central banks does little to address the fundamental economics problems which have caused the financial and economic crisis across the Europe. We still need to see radical changes if we are going to avoid the break-up of the Eurozone. So times are still very uncertain.

Chinese IPOs

It is not surprising that the European market in new initial public offers (IPOs) is pretty dead at the moment. With these stock markets currently in a state of high volatility there is little demand for new equity issues with investors deciding they would prefer to keep their funds in cash for the moment. However, there are still some international IPOs especially coming from the Chinese-based companies. Sadly many recent issues from this part of the World have been hit by scandals associated with some highly questionable accounting practices. As a result the Hong Kong market is now attempting to get involved as some Chinese private enterprises look to launch IPOs. In a recent article in the FT ("Hong Kong looks to private IPOs from China") there was a very good discussion of some of the regulatory issues involved in this process. The main focus was attempts to control the practice of "short-selling" which involves investors selling shares in these new IPO companies when they do not own them. This is a highly risky practice and it can be seen to cause even greater instability in new IPO issues. In a previous blog (September 2008) I explain more about this activity. You might like to read this to learn more!

New mandates at the Fed

In Articles 5 and 9 in the FT book the focus is on the Fed and the importance of the monthly employment release in the United States. As the latest meeting of the Federal Open Market Committee (FOMC) drew to a close yesterday it emerged that the US central bank is about to widen its remit to include an explicit unemployment target. The Fed has long had the dual role of ensuring price stability and full employment. However, the Fed chairman Ben Bernanke now recognises that the FOMC has failed to place enough emphasis on keeping unemployment at a low enough level. So it will now work on setting a formal target for unemployment as part of a more general overview of the way it goes about implementing monetary policy in the US. This will be important as the Fed were forced to now accept that the outlook for the US economy has deteriorated. It now suggests that US GDP will grow by 2.7% in 2012 compared to an earlier hoped for 3.5%. With this in mind we should expect to see the Fed opting to engage in a further round of quantitative easing as they try to stimulate economic activity.

Dividend growth in the year ahead?

The Financial Times ran a story today looking at the outlook for UK dividend growth in the next year. It gave the optimistic view that we might see them hitting a 12% growth rate which should be of some comfort to investors looking at large capital losses resulting from the sharp falls in share prices. Although the FT-SE 100 index has recovered a little in recent days it has still been a tough time for equity-based investments. It reminds us that shares are "risk capital" for the holders (the investors) and that in bad times equity investors suffer. The level of dividends is important and in the last year we have seen an increasing number of technology-based companies starting to pay dividends. This includes Cisco, Microsoft and Oracle. There are a number of strong arguments in favour of these types of companies getting the "dividend habit". Firstly, it will encourage a whole new group of investors to buy their shares. These are the types of investors who are looking for a reliable flow of income from their investments. Secondly, the payment of dividends can be seen as a clear signal of confidence from the management of the business. They are saying the company is doing well and that things should remain on an upward path. Finally, the payment of dividends reminds these companies that the primary aim of a company should be to provide the best possible financial reward to their shareholders. This takes us back to the start of the blog. At a time when share prices are depressed it is good news to see dividend growth so strong!

Berkshire Hathaway share buy-back

In late September the FT Companies and Markets section led with news that Berkshire Hathaway the US conglomerate run by Warren Buffet had announced plans to buy back its own shares. The company would be using part of their cash reserves to repurchase shares as long as they had to pay no more than a 10% premium to the company's book value and in addition ensuring their cash holdings remained at a minimum of $2obn. The impact on the share price was immediate with the A shares rising in value to $108,449. The interest in this story was especially strong because in the past Warren Buffet has been quite dismissive of share buybacks describing them as financial gimmickry. At the time financial markets welcomed this announcement as it was seen as a boost to investor confidence at a time when most news remains very gloomy.

Swiss National Bank (SNB) acts to depress its currency...

Yesterday the monetary authorities in Switzerland took dramatic action to halt the rising Swiss franc in the hope that such a move will help their exporters and head off a domestic recession. Put simply, the SNB said it would intervene aggressively in the foreign exchange markets in an attempt to get the exchange rate to their new target level of Sfr1.20 versus the euro. What will this mean in practice? The SNB is now committed to buy "unlimited" amounts of foreign currency and to sell the equivalent amount of Swiss francs. In recent months we have seen a massive overvaluation of the Swiss franc as investors have sought to invest in a "safe haven" currency at a time of of grave concerns about the eurozone sovereign debt crisis and the related turmoil on the financial markets. This has seen the Swiss franc rise to Sfr1.0075 against the euro. As a consequence it has become very hard for Swiss exporters to compete as the appreciation has made their products much more expensive in foreign currency terms. With the export sector so important to the Swiss economy this has led to a sharp domestic slowdown in economic activity. The impact of the SNB announcement was immediate with the euro rising over 8% against the Swiss franc. In the light of these moves within Switzerland there are now clear fears of a currency war developing with other Countries also seeking to devalue their own currencies. We live in interesting times!

Corporate governance back in the news!

In today's business newspapers the Kazakh-owned mining firm ENRC is heavily featured. There are some strong criticisms being voiced in terms of the ongoing corporate governance row that has seen some high profile British-based Directors being voted off the board. ENRC, which is listed on the London Stock Market, reported surging first-half profits despite rising costs, as it was boosted by higher metal prices and increased demand from China. The company's profits hit £986million which represents a 33 per cent increase on the previous year. Despite the figures the concerns about the corporate governance issues are the main reason that the company's shares are trading at a 20% discount to its rivals. The background to this story is that a few months back the company's majority shareholders (Kazakh-based) declined to endorse the re-election of the senior independent director, Sir Richard Sykes, the former Head of Glaxo Smithkline. At the time there were suggestions that his demise owed much to him querying the independence of the Chairman Johannes Sittard who is closely aligned to the Kazakhs. There are also worries about the company's Chief Executive Felix Vulis and in particular his failure to reduce the dependence of the company on its Kazakhstan-based operations.

ECB raises interest rates!

Today we saw an excellent example of the different priorities of the Bank of England (BE) and the European Central Bank (ECB). For the BE the key is to continue to support the level of economic activity in the UK. So despite the level of consumer price inflation remaining well above the target level the Monetary Policy Committee made no change in interest rates which have been at 0.5% for over two years. In contrast the Governing Council of the ECB has raised interest rates from 1.25% to 1.5% in an attempt to reduce the level of inflationary pressures across the 17-nation eurozone. The ECB's President Jean-Claude Trichet sought to explain this move by saying that inflation, now 2.7%, was likely to remain "clearly above the ECB's 2% target over the coming months". In a clear warning about the future he said inflation would be monitored closely in coming weeks and this has been seen as a signal that rates are likely to go even higher. The ECB's rise was widely anticipated with their economists being concerned about the possible "upside risks" to inflation in the medium term.

BT's Dividend signal

In Topic 9 of the second edition of the book I took a look at the very important subject of dividend policy. In the introduction to this section I discused the clientele effect and the information that can be contained in the dividend announcement. A good example of these two factors in practice came along in last Friday's FT (page 20 Companies and Markets) with Andrew Parker discussing BT's latest figures which showed a 71% increase in pre-tax profits for 2010/11. However, of even more significance for their shareholders was the group's hint that dividend policy might be more generous in the future as a result of a sharp fall in their pension fund deficit. With the company generating £2.2bn of free cash flow it was able to raise the annual dividend by some 7% to 7.4p per share. This was contrasted with BT's decision to cut their dividend payouts two years ago due to lower than expected earnings and the need to increase the company's payments into the pension fund. It is now expected that the pension scheme is in far better financial shape and it is against this background that the company can now look to signal a more generous dividend policy in coming years. So if we take the dividend announcement as "an important signal to investors" BT is presenting an optimistic viewpoint.

Chinese inflation on the rise!

The latest data out on Friday showed that Chinese inflation had risen to an annual rate of 5.4% in March. This came with further evidence of the overall strength of the economy with first quarter GDP growth hitting close to 10% pa. It is clear from this that the World's second largest economy is still powering ahead. This is despite a period of aggressive monetary tightening led by the Bank of China as the Government has made it clear that they have set the control of inflation as their number one policy aim. The central bank's policy measures have included increases in interest rates and much tighter required reserves. There is an obvious concern within government circles about the possible impact of rising food prices on family budgets. The scope for resulting social and economic unrest is a clear worry. This might suggest that the Chinese government will again be forced to employ direct price controls on the food sector. While this might help a little the problem is that Chinese inflation is this time more broadly spread so the impact of controls on one part of the consumer price index will be limited.

Greece and Portugal: The Government bond crisis continues...

In article 12 of Reading and Understanding the Financial Times (page 64) I looked at the issue of a 50-year government bond issue by Greece from back in 2007. A that time they were able to issue these securities at a spread of just 30-35 basis points (see key terms on page 66 to see this concept fully explained) above the equivalent German government bonds. How things have changed since then! This week we have seen the leading agency S&P cut the sovereign credit rating of both Greece and Portugal. In relation to Greece the rating is down to BB- while Portugal's is a little better at BBB-. The result of these developments is that both Countries now face much higher borrowing costs. As a result of this downgrading the spread between Portuguese and German borrowing costs surged to 467 basis points. The Greek spread widened to 938 basis points.

Monetary Policy Committee a four-way split!

In Article 8 (page 40) of the latest edition of the book I discuss the role of the Bank of England's Monetary policy Committee. As I state in the "key terms" section:

"The Bank of England’s Monetary Policy Committee (MPC) is in charge of setting UK interest rates. It is made up of nine members:

The Governor
Two Deputy-Governors
Two Bank of England Executive Directors
Four independent members.
They are required by the Government to ensure that the UK Economy enjoys price stability. This is defined by the Government’s set inflation target of 2%".

At the moment there is a heated debate among the members of the MPC with the latest minutes from the February meeting showing a four-way split for the first time in the history of this UK key financial institution.

Two members of the MPC wanted to see a 25 basis point increase in the Bank's Repo Rate.
Another member (the ultra hawkish Andrew Sentance) wanted an immediate 50 basis point increase.
One member (the ultra Dovish Andrew Posen) wanted to see a substantial boost to the quantitative easing (QE) programme.

The rest of the committee saw their view hold sway with no change in either the QE programme or in the Bank's Repo Rate. Given the recent upward trend in UK consumer price inflation it seems clear we will start to see a period of monetary tightening from the MPC in coming months. The timing is hard to predict but I would be surprised if we do not see the first increase in interest rates in the next couple of months. We just need two of the MPC's middle road members to join their more hawkish members in voting for some monetary tightening.

Rising inflation in the UK and China!

In the last week we have seen confirmation that the risk of inflation remains a serious problem in a number of parts of the World. The latest UK data showed that annual consumer price inflation rose to 3.7% in December 2010. This is particularly worrying as it was clearly not forecast by the Bank of England. Back in early 2010 the Bank seemed confident that UK inflation would be back under 2% by year end. Not surprisingly this has led to widespread criticism of their forecasting record which will seriously damage the credibility of the Bank of England. It still argues that this latest rise in inflation is mainly due to a number of short-term factors. However, the financial markets are now anticipating that the UK central bank will be forced to start raising short-term interest rates by the early summer.

At the same time there are clear signs that the overheating Chinese economy is being reflected in rising price pressures with annual inflation hitting 4.6% in December 2010. This official estimate is widely seen as an underestimate of the Chinese inflation as national and regional government officials are still able to intervene to limit some prices rises. There is even greater concern about the real estate market where some areas showing annual price rises of close to 50%. If there was a sudden and sharp correction in the Chinese property market this could have a dramatic impact on the financial security of the banks which have financed this boom. Against this background the Chinese authorities will be keen to see a gradual rather than any sharp economic slowdown.

Problems at Candover show tough times for private equity firms...

In the second edition of the FT book published this time last year I updated Topic 8 with an article about the UK private equity firm 3i. This acted as a sharp contrast to the Boots case study which was included in the first edition. At that time private equity was going through a boom with a vast amount of deals making the firms and their partners very rich. These days it could hardly be more different. Successful private equity deals rely on the availability of cheap debt finance and a rising stock market. At the moment the availability of borrowed money remains a problem and share prices are at best volatile. Against this background Candover Investments, the private equity group, is attempting to make a serious re-structuring of their business. The FT reports today (page 18) that the firm is seeking to "spin-off" its buy-out arm and sell a third of their investments. These moves will confirm the sad deterioration of the firm which has moved from being a star of this sector to its current very depressed state. The latest announcement from the company reveals that Candover Partners Limited, the buy-out arm, will be sold to Arle Capital Partners which is a new private equity group that has been set up by its own managers. The plan is also sell about £60m of their investments in order to reduce the debt burden. These developments show the continuing problems of the private equity sector. It seems such a long time ago when these firms appeared to be so invincible. In finance times change very fast.

EasyJet promises dividends....

I recently had the good fortune to visit the London School of Economics to do some guest lectures on "Reading and Understanding the Financial Times". This was the first time I had been back to LSE since I had been a student there in the early 1980s. The many students who came to my sessions were very impressive with such a strong focus on their current studies as well their future careers. Indeed I focused on showing them how to interpret current FT stories as many of them were busy preparing for internship interviews. I am sure they will be very successful in securing many of the good opportunities available in the investment banks and other financial institutions. So I would like to thank the Presidents of the "Finance" and "Investment" societies in particular for the invitation to go back to LSE. This latest update to my website is dedicated to all the students that came to see me speak....

So now to business... In the latest edition of the book I have included a new story on the outlook for EasyJet (page 15). I can now update that story with reference to today's FT. If you read page 22 of the "Companies and Markets" section you will see an excellent article focusing on the company's new Chief Executive (Carolyn McCall) who gave an update on the company's prospects. It was largely good news with a sharp rise in profits and the headline decision to start paying dividends for the first time ever. This is a powerful signal of the growing maturity of the business and the clear confidence that the company's profitability will remain strong in the future. If you read pages 147-149 of the book you will see how dividend announcements play an important role in corporate finance. At the bottom of page 148 I discuss the "information content" of dividend announcements. In this case the decision to announce the start of dividend payments is a clear signal from the new boss of EasyJet that she is confident that the company can maintain these payments in the future. If she had any serious doubts about this there is no way a decision to start paying dividends would have been made. So as you can see these sorts of announcements are very important in practice as well as in corporate financial theory.