A $1.8 Billion Accounting Error?
Both the S&P 500 and the Nasdaq sold off this week as the volatility index rose to its highest level this year. Volatility has been abnormally low since the end of November 2023, which makes this sudden increase feel a little uncomfortable. Given the recent developments in the Middle East between Israel and Iran and the continued conflict in Ukraine, it appears reasonable that investors are becoming a little uneasy. Coupled with anxiety over inflation and the lack of interest rate cuts, you have all the ingredients necessary for the recent market downturn.
Among the many stories making headlines, we’ve entered earnings season. This is always a bit of an unknown as companies often massage their messaging to set expectations for the coming quarter or year. What has struck me so far is that pricing may no longer be a lever companies can pull to beat expectations. For example, Procter & Gamble reported earnings this week and beat expectations by $0.11 per share, growing EPS by 18% year-over-year. However, it was noticeable that organic sales only rose 3% versus the expectation of almost 4% on lower volumes. What this says to me is that earnings had been able to grow primarily on the back of price hikes not increasing volume. I am left wondering how many other companies are in the same situation as consumers are all but exhausted by inflation and are increasingly becoming more price-sensitive.
Along the same lines, Netflix reported both top and bottom-line beats but surprised analysts by saying it would no longer release subscriber numbers beginning next year. Netflix has been notorious in recent years for regularly increasing its pricing while simultaneously adding a lower-price ad-supported plan and regularly canceling well-received shows beyond the first or second season. The only rational explanation for not releasing subscriber numbers is if the company believes it will disappoint as continued price hikes drive some customers away. This gets back to P&G and all the other retailers that have increased earnings not by increasing volumes but by increasing prices. It seems those days will soon be over if they aren’t already, and companies will need to do a better job of offering a value proposition that keeps customers returning.
On a different subject, we learned this week that the Biden administration intends to award all CHIPS Act grants this year. The CHIPS and Science Act is aimed at bolstering domestic manufacturing and reducing reliance on other countries. When this $52.7 billion bill was passed in August 2022, many assumed it would be doled out over a period of many years. The pace of grants has been faster than many expected and perhaps timed with the end of Biden’s term as president. The awards so far have focused on advanced chips, with Intel securing $8.5 billion, Taiwan Semiconductor awarded $6.6 billion, and GlobalFoundaries $1.5 billion. This week Samsung was awarded $6.4B to expand its existing facility in Austin Texas, to produce critical chips for aerospace, defense, and automotive applications. I am of two minds regarding these grants. It allows these companies to build or expand their presence in the United States which is a good thing for both national security and regional growth. On the other hand, money is fungible and in the last week, both Oracle and Microsoft announced multi-billion-dollar projects, $8 billion and $2.9 billion respectively, to build datacenters for artificial intelligence and cloud infrastructure in Japan. It seems to me if projects are profitable, companies would invest in them. I feel torn by the idea of subsidizing these companies at taxpayer expense, while simultaneously understanding the national security implications of being exposed to foreign production. It is indeed a conundrum.
In closing, I turn to a story that seems impossible but is nonetheless true. A couple weeks ago I read with amazement that South Carolina has a big mystery on its hands. According to the report, $1.8 billion was found in a bank account controlled by the state, and no one knows how it got there. The governor of South Carolina, Henry McMaster, in perhaps the greatest understatement in history said, “There’s something wrong somewhere.” To put it mildly, what do you do with $1.8 billion when no one knows how it got there, how it should be spent, or even whether it really exists. Last year, the state comptroller resigned after the discovery of a 10-year, $3.5 billion accounting error. State lawmakers say the sum could be related to that scandal, but no one knows. The mystery money was discovered last October, but state auditor George Kennedy III recently said in a hearing he knew about it in 2017 but assumed it was in the account temporarily. If you happen to be missing $1.8 billion, I’d encourage you to reach out to the state of South Carolina. Now you know.
Bruce J. Mason, MBA