This week we could discuss the US jobs number, which at just over 100,000 new jobs created was less than half of the median expectation for March and was disappointing, to put it mildly. But it’s only one month, and, we suspect, an aberration.
For this column to change its optimistic stance of recent weeks we would need to see this pattern repeated for the next two-three months. So no need to discuss it here for now, fingers crossed the April non-farm payrolls is back up to “200” big figure (as I expect it will be. A few more months at that level and President Obama’s re-election is virtually assured).
Instead let's discuss two items from the mainstream news today, because they serve as worthy pointers to the fact that, even though we are on the cusp of recovery on both sides of the Atlantic, we need to remember that there is plenty that can still go wrong and one must remain cautiously optimistic, with the emphasis on cautiously.
The more arcane headline concerned a corporate entity in China, a fiber company called Shandong Helon and its 1-year commercial paper liability maturing this month. The company had been suffering from debt servicing problems, resulting in a downgrade from BB- to B, and there was a widespread view that it may default on the CP.
This would have been something of a precedent because there has never been a default in the nascent Chinese corporate debt market, but there is a wider implication concerning risk pricing in this sector. International investors had seemingly viewed the Chinese corporate debt market as implicitly backed by the government, under the assumption that the authorities would be loathe to witness a corporate default. This view then fed through into debt pricing.
But as any genuinely open and transparent capital market would testify, one can’t have progress and redemption payments without occasional setbacks and defaults. The news this week was that timely repayment would indeed be made by Shandong Helon, which although undoubtedly gratifying news for the company’s investors, means that an essential step in the maturing of the market will have to take place at a later date.
The corporate sector in China is not backed by the government explicitly, and sooner or later will experience a default. Investors need to be aware of this and factor it into their risk-reward profiles. A default will provide external observers an opportunity to assess how the market reacts to the news and how the enforcement of legal contracts is undertaken, and is a crucial ingredient in shaping a market. As the Chinese economybecomes an ever larger part of the global economy, it will be important for investors to be familiar with how it fares in bad times as well as good.
On a similar theme of potential mispricing, we note that Facebook is acquiring a company called Instagramfor $1 billion. That is certainly a nice round number (one would have positively relished a valuation of, say, $937 million if only because that would have suggested at least some sort of orthodox due diligence) and it is evident that the company’s product, a photo-sharing application, fits in with the Facebook business model. But Instagram has no current recognizable revenue stream. One billion dollars? The mind boggles.
The seminar topic at any university’s graduate finance course this week should be: “Adding pure speculative sentiment to a large and idle cash pile creates an unsustainable asset price bubble. Discuss”.
_________________________ "The views expressed in this article are an expression of the author’s personal views only and do not necessarily reflect the views or policies of The Royal Bank of Scotland Group plc, its subsidiaries or affiliated companies, or its Board of Directors. RBS does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. This article does not constitute an offer or a solicitation of an offer with respect to any particular investment."
The author is Professor Moorad Choudhry is Treasurer, Corporate Banking Division, Royal Bank of Scotland.
"The views expressed in this article are an expression of the author’s personal views only and do not necessarily reflect the views or policies of The Royal Bank of Scotland Group plc, its subsidiaries or affiliated companies, or its Board of Directors. RBS does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. This article does not constitute an offer or a solicitation of an offer with respect to any particular investment."