Wealth Shock: The Case of Apple in 2018

• Author: Louis Le Guyader
• Published date: 01 April 2019
• Date: 01 April 2019
• DOI: http://doi.org/10.1002/jcaf.22380

EDITORIAL

Wealth Shock: The Case of Apple in 2018

Louis Le Guyader

1|INTRODUCTION

In fiscal 2018, Apple reported over $3.5 billion in securities'

losses. With this, the securities losses on Apple's balance

sheet had accumulated to over $4.3 billion. These losses

were shielded from view by accounting rules that kept them

out of Earnings. On Apple's balance sheet, its securities port-

folio shrunk by this amount as did its equity account. For

various reasons the losses did not reduce the company's

“free cash flows.”

Such losses are a “wealth shock.”Wealth shocks are the

“down side”of wealth effects. They are losses that map into

a wealth decrease. The losses were not directly caused by

management. These particular shocks arose because external

market interest rates rose. As a result, there was a drop in the

market value of Apple's fixed income securities, its “market-

able securities.”Since Apple's equity account also

decreased, the wealth decrease is plainly visible.

Wealth shocks of these kinds impact the company's bal-

ance sheet but not its earnings, and not its cash flows. They

deserve special attention in the current economic cycle of

the United States because they are caused by an external fac-

tor, interest rates, that has risen. This article explains why

Apple's shareholders appear to have correctly interpreted the

accounting system's signal and ignored this shock. This arti-

cle will also explain why the shock, using the same set of

signals, likely factored into management's apparent decisions

to allow the securities already held to mature rather than lock

in losses.

2|THE THEORY OF WEALTH

EFFECTS

2.1 |Economic Theory

Economists have described “wealth effects”as increased

spending by an affected party that perceives its wealth has

increased. The setting most frequently discussed is that of an

investor who owns a portfolio of assets. The portfolio's

assets are exposed to external price increases. The portfolio

has a higher market value because its assets' values price

have increased. The investor's position appears to have

improved—their wealth has increased. Under these circum-

stances, the investor will (or should) spend some of that

increased wealth, at least in theory. And the new spending

should occur even if the appreciated portfolio in question is

not liquidated for that purpose (Cooper & Dynan, 2014).

Economists are not certain if price changes map through

to observable investor behaviors. Documenting the causal

link is daunting. Many dots must be connected. But the the-

ory is workable even with this problem. The economic the-

ory is problematic when the dots connecting increased prices

to wealth increases and consumption increases cannot be

connected. The worst case is one where the simultaneous

increases that should be connected might in fact represent

independent unassociated events. In the worst case, if a posi-

tive correlation can be measured but the causal connection

does not exist, it is a statistical nightmare that is labeled

“spurious.”

“Wealth effect economics”should apply to all asset clas-

ses, not only assets that can be assembled into portfolios.

That brings us to Apple's fixed income securities. And these

dynamics should be observable even if an intermediary is

placed between the ultimate investor and the asset position.

The intermediary is Apple's accounting system. Shareholders

invest in Apple, and then Apple invests in securities. The

investors only have an indirect interest in the securities as

shareholders of Apple.

Wealth shocks are a special case of wealth effects. As

asset prices decrease, measurable paper wealth decreases.

The decrease in wealth should cause consumption to

decrease. The slowdown in consumption should be corre-

lated to the perception that wealth has declined.

We expect to see the investor impact, or lack thereof, in

Apple's stock price. Since management must “husband”

company resources, changes in the value of the most liquid

Received: 8 March 2019 Revised: 9 March 2019 Accepted: 11 March 2019

DOI: 10.1002/jcaf.22380

J Corp Acct Fin. 2019;30:7–12. wileyonlinelibrary.com/journal/jcaf © 2019 Wiley Periodicals, Inc. 7