Invisible Gorillas

This note was originally published at 8am on April 27, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Miracles happen everyday, change your perception of what a miracle is and you'll see them all around you.”

-Jon Bon Jovi


The Invisible Gorilla was an experiment performed by Professors Christopher Chabris and Daniel Simons at Harvard University in 2004.  In the experiment, candidates were asked to watch a short video of six people, three in white shirts and three in black shirts, pass a basketball around and count the passes. At a point in the video, a gorilla wanders into the action, faces the camera and pounds its chest.  In total, the gorilla is on screen for almost 9 seconds.


In theory, a gorilla wandering into the middle of an otherwise normal scene sounds like an event that would be relatively easy to notice.  The results, on the other hand, suggest otherwise.  Professors Chabris and Simons found that almost 50% of the people that watched the video did not notice the gorilla.  In fact, it was as if the gorilla was completely invisible. 


There are two key takeaways from the experiment.  First, we miss a great deal of what happens around us.  Second, we actually do not even realize that we miss things.  As stock market operators, we obviously pride ourselves in attention to detail and acute analytical skills.  The fact remains that both your and my skills of perception are just not as strong as we believe them to be.


As I think about this experiment, the scariest thing to me is the idea of overconfidence.  I would imagine that most of you believe that if you were to watch the video, you would see the gorilla.  The reality, though, is that only 50% would see it.  You may believe you have great skills of perception, but the facts suggest otherwise.  But, if you know just that, then you have a leg up on the competition.


I will give you an example of a hidden gorilla in the investing world.  Apple recently reported earnings and while Hedgeye currently doesn’t have a technology analyst, we had a healthy debate in our morning meeting on the stock.  On one side there were the bears who basically opined that Apple was a product cycle company and was only as good as its next product, that margins on its hardware sales inevitably had to revert to the mean, and, basically, that Apple couldn’t justify its valuation longer term.


On the other side of the debate was the Hidden Gorilla argument.  In effect, the proponents of Apple in our morning meeting argued that it is somewhat irrelevant to argue about price points on Apple hardware products or fret over the number of iPhones that were sold in the quarter because Apple is actually a software company.  Specifically, via its iTunes online store Apple has become the go-to marketplace for all critical digital content on the internet (from movies to music to books to TV shows to games).  In that business, Apple keeps 30% of the revenue and the publisher keeps 70% of the revenue, but unlike other ecommerce businesses, like say Amazon, Apple has no physical infrastructure costs so the business in theory generates very high and sustainable returns on capital.


Yesterday, Jeff Gundlach gave a really interesting presentation on his general view of the global economy.  He had one slide that discussed Apple and made a comparison between Google’s rapid rise and decline with the conjecture that as Apple effectively “becomes the market” it may have a similar path in the future.   Gundlach may be right on Apple, or in fact he may be missing the Invisible Gorilla, which is that Apple is a much better long term business than its valuation suggests. 


In the Chart of the Day today (yes it incorporates a picture of a gorilla), we compare the overall unemployment rate in the United States versus the unemployment rate for those aged 16 – 24.  In the U.S., the unemployment rate is currently 8.2% and the unemployment rate for the youngest demographic is double that at 16.4%.  This is perhaps the hidden gorilla in the U.S. economy, which is that the youngest demographic is massively underemployed.


In Europe, the unemployed ratio of the youngest demographic versus the average is even more extreme.  Spain exemplifies this more than any major European economy.  This morning Spanish unemployment ticked up to 24.4%.  Youth unemployment in Spain also ticked up, to a staggering 52.0%.  Trust me when I say this: a generation of unemployed is not a positive leading indicator for the outlook of any nation or region.


So, not surprisingly given the employment data the Spanish 10-year yield is back up testing the 6% line this morning. The only real positive indicator I have found as of late is that the perpetual contra indicator Standard & Poor’s cut Spain’s credit rating for the second time this year from A to BBB+ “citing struggling banks and deficit concerns”. Of course, it does beg the question . . . why was Spain rated A to being with?  But, who knows, perhaps the Invisible Gorilla in Europe is that rating agencies will get this one right . . .


While we are on the topic of European sovereign debt, Italy held a debt auction overnight.  In fact, Italy sold €5.95 billion of BTPs with 4-10 years maturity versus a maximum target of €6.25 billion. The 10-year average yield was 5.84% versus 5.24% prior and the bid-to-cover was 1.48 versus 1.65 prior.  Not even the Invisible Gorillas were buying at this auction.


Before winding this note down, I wanted to flag a call out from my colleague Darius Dale in a research note on Japan yesterday.  He wrote:


“As it stands now, Ozawa, who remains one of the most influential members of the ruling Democratic Party of Japan (w/ influence over up to a third of the party by some estimates), opposes the DPJ’s VAT hike bill. His exoneration means he is now free to stir the pot and rally support to defeat the bill from within. Further, his platform centers on expansionary fiscal policy, which, in addition to wanting a shot at regaining full control of the Diet via a snap election, is preventing the LDP from coming to the table to negotiate with the DPJ on its VAT hike proposal.”


Ichiro Ozawa has gone from being the Invisible Gorilla to being the 1,000 pound gorilla in the room, which according to Darius increases the risk that the VAT tax may not get passed and Japanese debt gets downgraded.


Perhaps the miracle that Jon Bon Jovi speaks of in the quote at the start is that we will get out of this global sovereign debt mess unscathed, or, at the very least, that it won’t end all that poorly.  Personally, I remain skeptical.


Keep your eyes out for invisible gorillas,


Daryl G. Jones

Director of Research


Invisible Gorillas - Chart of the Day


Invisible Gorillas - Virtual Portfolio

Optimistic Bias

“The optimistic bias may well be the most significant of the cognitive biases.”

-Daniel Kahneman


If I had to pick three books that have been the most influential in my learning process in the last few years, they would be: 1. This Time Is Different (Reinhart & Rogoff) 2. The Road To Serfdom (Hayek), and 3. Thinking, Fast and Slow (Kahneman).


The only way out of getting caught off-sides by the groupthink of our profession is to get into books. I think it’s critical to remove your mind from the daily dose of hope and get real with what’s not only happened across generations of economic history, but what’s developing in terms of what we’re learning about ourselves.


I call this being Duration Agnostic in my risk management approach. Long-term mean reversions in big Global Macro data and immediate-term behavioral factors in our heads matter, all at the same time. Embrace Uncertainty.


Back to the Global Macro Grind


If you loved the US stock market 7 trading days ago, you’re going to get married to it this morning. Or are you? Do you have to keep buying on the way down? When the facts change, do you? I don’t marry markets.


I can’t imagine anyone telling me with a straight face that they thought that JPM reporting a $2B loss on the eve of Durbin taking the Volcker Rule implementation to the Senate floor was either expected or reason to be optimistic. With both JPM and the Financials (XLF) having already broken my intermediate-term TREND lines of $41.14 and $14.99 support, respectively, timing here matters.


I’m not dog-piling bad news. In fact, from a leadership perspective, Dimon showed his stripes as being the real deal in terms of transparency and accountability last night. That doesn’t make this a ‘buy the Financials’ day though (see Chart of The Day).


On the margin, the fundamental news for the US Financials has been worsening for at least 2 months. As one of our top performing Risk Manager clients asked last night – “So, what do you think is already priced in?”


The short answer is I don’t know. We let the market tell us what to do next.


The more well rounded research and risk managed answer is something that our Managing Director of everything Financials, Josh Steiner, and I will host a conference call on at 830AM EST (email if you’d like to join).


What else do we know?

  1. The concept of the US “de-coupling” is as loose as Keynesian economic forecasting
  2. Globally Interconnected risk, across currencies, countries, and commodities, continues to flag bearish
  3. Whatever your bottom-up view is on the Financials, it has to be considered within the context of the top-down

We do Top-Down in 2-ways:

  1. Global Macro Top Down
  2. Industry Top Down

On the Global Macro front, here’s what I see across currencies, countries, and commodities right now:

  1. US Dollar Index up for the 8thconsecutive day to $80.20; EUR/USD moves back into a Bearish Formation
  2. US Dollar Index immediate-term correlations: SP500 = -0.91, EuroStoxx600 = -0.95, CRB Commodities Index = -0.95
  3. US Dollar Index  immediate-term correlation to the US Financials Sector ETF (XLF) = -0.92

In other words, the Correlation Risk is moving towards -1.0, again – and if you don’t remember how this movie tends to climax, you are definitely hostage to a serious Optimistic Bias. This is not a time to be recklessly long on a gross or net basis.


The Correlation Risk to the world’s reserve currency doesn’t always matter. But when you are in the soup like this, it’s basically all that matters. That’s the lesson of the 2008, 2010, 2011 Q1 peaks to the ultimate draw-down lows established sometime in Q3.


Valuation is not a catalyst right now. Events are. From a Top Down Industry perspective for the Financials, here’s what’s next:

  1. Morgan Stanley’s pending multiple notch ratings downgrade (May)
  2. Volcker Rule implementation (July)
  3. Europe (ongoing)

Notwithstanding that the US Money-Center banks are going to have to also report earnings in July – and that one of the main drivers of those cash earnings, Net Interest Margin (NIM), has seen the Yield Spread (10yr minus 2yr yield) compress by 21% since it topped in mid-March, there’s a lot to think about here.


If every single major Global Equity market hadn’t already put in a lower long-term high in late-Feb to early April, I would answer my client’s question with a maybe (in whether or not I think this is all priced in). But they have. So my answer is not maybe. You don’t pay me to be optimistic – you pay me to be realistic about real-time risk.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Financials (XLF), JP Morgan (JPM), and the SP500 are now $1, $109.71-113.87, $79.42-80.39, $13.87-14.99, $36.83-41.14, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Optimistic Bias - Chart of the Day


Optimistic Bias - Virtual Portfolio

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TODAY’S S&P 500 SET-UP – May 11, 2012

As we look at today’s set up for the S&P 500, the range is 26 points or -1.25% downside to 1341 and 0.66% upside to 1367. 












    • Up from the prior day’s trading of -1080
  • VOLUME: on 5/10 NYSE 784.06
    • Decrease versus prior day’s trading of -16.60%
  • VIX:  as of 5/10 was at 18.82
    • Decrease versus most recent day’s trading of -6.23%
    • Year-to-date decrease of -19.53%
  • SPX PUT/CALL RATIO: as of 05/10 closed at 1.60
    • Down from the day prior at 1.65 


  • TED SPREAD: as of this morning 38
  • 3-MONTH T-BILL YIELD: as of this morning 0.09%
  • 10-Year: as of this morning 1.85
    • Decrease from prior day’s trading at 1.87
  • YIELD CURVE: as of this morning 1.59
    • Down from prior day’s trading of 1.61 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Producer Price Index, April, est. 0.0% (prior 0.0%)
  • 9:15am: Fed’s Fisher speaks in Fort Worth, Texas
  • 9:55am: UMich Confidence, May prelim, est. 76.0 (prior 76.4)
  • 11am: Fed to buy $1.5b-$2b notes in 2/15/2036 to 2/15/2042 range
  • 1pm: Baker Hughes rig count 


    • SEC Chairman Mary Schapiro speaks at Investment Company
    • Institute’s general meeting, 8am
    • House meets in pro-forma session, Senate not in session
    • CFTC holds closed meeting on enforcement matters
    • FDA advisory panel meets on safety, effectiveness of weight- loss devices stomach balloons, bands and sutures, 8am
    • Transportation Dept. holds meeting on commercial space transport, 8am    


  • JPMorgan CEO Jamie Dimon said the firm suffered a $2b trading loss after an “egregious” failure in a unit managing risks
  • Facebook IPO said to receive weaker-than-expected early demand
  • Facebook IPO overvalued at $96b in global investors’ poll
  • Yahoo! CEO Scott Thompson said to have told executives he didn’t provide resume
  • EU maintains forecast for 0.3% euro-area contraction in 2012,
  • sees euro-region economy expanding 1% in 2013
  • Dewey & LeBoeuf employee lawsuit says 450 firings to come today
  • China’s industrial production grew least since 2009 in April, retail sales rose less than est., inflation below tgt
  • IEA sees tighter oil market, high prices amid Iran supply risk
  • Toyota surpasses GM in global auto sales in 1Q 2012
  • Japan’s central bank revised its guidelines for reserve mgmt, pledging liquidity in case of global emergency
  • Gilead HIV pill wins FDA panel backing as first to prevent virus
  • Gilead faces vote from FDA panel on Quad pill for HIV
  • Arena Pharmaceuticals Inc.’s weight-loss pill gained the backing of a FDA advisory panel; call today at 8am
  • German Finance Minister Wolfgang Schaeuble suggested the euro area could handle Greece dropping out, raising pressure on Greek political leaders struggling to form a govt. amid a rise in anti-bailout sentiment 


    • Enerplus (ERF CN) 6am, C$(0.01)
    • TMX Group (X CN) 6am, C$0.88
    • Nvidia (NVDA US) 7:30am, $0.15
    • B2Gold (BTO CN) 8:41am, $0.06
    • Emera (EMA CN) 9:48am, C$0.71
    • Katanga Mining (KAT CN) Pre-mkt, $0.01
    • Iamgold (IMG CN) Post-mkt, $0.26 


  • Gold Bulls Weakest in Month as Investors Buy Dollar: Commodities
  • Oil Heads for Second Weekly Decline on Europe, Excess Supplies
  • Cotton Declines to 21-Month Low on Increasing Global Stockpiles
  • Commodities Erase Advance for the Year in Worst Run Since 2008
  • Copper Heads for Second Weekly Drop on Slowing Chinese Economy
  • Gold Declines to Four-Month Low as Europe Concern Boosts Dollar
  • Corn Prices Decline After U.S. Forecasts Gain in Inventories
  • Cocoa Falls After Ghana Sells and Money Managers’ Holdings Rise
  • China’s Gold Demand Seen Flat as Economy Slows, Price Drops
  • Cooking-Oil Imports by India Jump on Lower Domestic Supplies
  • Oil May Fall on Greek Struggle to Form Government, Survey Shows
  • Iraq Oil Output Beating Iran Ends Saddam Legacy: Energy Markets
  • Chinalco Said to Seek $1 Billion in IPO of Peruvian Mining Unit
  • Commodities Decline in Worst Run Since 2008
  • China’s Backing Signals Pan American Is No YPF: Argentina Credit
  • Palm Oil Drops by Most in Five Months as Malaysian Exports Fall
  • India to Export Wheat From State Reserves After Granaries Swell 









SPAIN – back into crash mode this morning ahead of whatever this next central bad bank plan is going to be, down -1.3% (down 22% from YTD high); rests of Europe mean reverting to the crash tapes. Professional Knife Catchers, Unite.


RUSSIA - down another -1.9% this morning (down -16.6% since March 14th when most Global Equity markets topped for the year) and this is a good example of why the USD Correlation Risk matters so much – Russia is a Petro Dollar market, so with the USD up for the 8th consecutive day (and the Petro snapping my $113.87 Brent line), this is not good.






CHINA – Growth Slowing data continues to roll in on both Industrial Production (+9.3%, lowest since April 2009) and Retail Sales (+14.2% vs 15.3% in March), but so does Deflating The Inflation w/ Chinese CPI under control finally at 3.4%. Just like I said in 2009, I say you buy China when the growth data is slowing at a slower rate and inflation improves. Chinese stocks down -0.6% on the “news.”










The Hedgeye Macro Team

JWN: 1Q12 Report Card


You have to be hiding under a rock not to know that things got worse on the margin in the department store space. First Macy’s, then Kohl’s…but high-quality Nordstrom should be immune, right? Hardly. The good news is that comps (known) were 8.5%, with total sales ringing in at 13.2%. The comp accelerated on both a 1yr & 2 yr basis with categories like high end hand bags as a key area of outperformance. This reaffirms strength we’re perennially seeing in the domestic luxury accessory market, marking a stark contrast to low end retail. The bad news is that with such impressive top line, the company only put up a 2.9% EBIT growth rate. Some people will chalk up the weak margins to one-off investments in e-commerce. But ecommerce is here to stay, and increased investments will need to as well. Also, Free Shipping hurt margins. Free shipping is like sticking a needle in the consumers’ arm – it’s very difficult to wean them off once they get a taste. Lastly, inventory per square foot was +16%, which the company made a noble effort to explain away as not being a concern. We’ll point to the -6% sales/Inventory Spread – just edging out Kohl’s as the worst in the department store space quarter to date, and a sequential decline from -5% last quarter. Then again…JCP has yet to report. Maybe then JWN can hold on to hope that Johnson and team will steal this prize.


What Drove the MISS?

Although credit sales came in slightly better than expectations (flat vs -14E) resulting in total revenues +13.2% vs +12.6E, gross margins came in light -31bps vs +33E resulting from free shipping to fashion rewards customers. With ramped up investment spending largely in line with consensus, operating margins were (-106bps) vs (-35E) driving the nickel miss. Despite strong top line trends with comps +8.5% driving a 100bps acceleration in underlying two years trends, JWN left full year EPS outlook unchanged at $4.30-$3.45 vs. $3.49. The only key delta in full year guidance was a $10mm pullback in credit SG&A to offset an incremental $10mm in retail investment in additional e-commerce enhancements. 


JWN: 1Q12 Report Card - dept store SIGMA


JWN: 1Q12 Report Card - high low end chart


Deltas in Forward Looking Commentary?


In order to properly measure performance relative to original expectations, we look at management’s 2012 guidance headed into the quarter as well as the key deltas in Q1 results vs. expectations :






  • We expect to achieve 2012 EPS of between $3.30 and $3.45, with same-store sales between 4% to 6% UNCHANGED
  • Our plan for the 53rd week will increase our annual sales and EPS by approximately $160mm to $170mm and between $0.03 and $0.05, respectively UNCHANGED

Gross Profit

  • Our 2012 gross profit rate will range from 5 to 35BPS lower than last year UNCHANGED
  • This primarily is a function of the near-record performance of merchandise margin in 2011, along with the unfavorable gross profit impact from an increasing mix of Rack stores, the reduction of shipping revenue, and the introduction of our enhanced Fashion Rewards program


  • We anticipate retail SG&A to be $265mm to $330mm higher than last year INCREASED $10mm to support additional E-Commerce investment spend
  • Credit card revenue is expected to be flat to up $10mm, with no anticipated growth in credit card receivables, due to increased sales volume being offset by higher payment rates UNCHANGED
  • Our Credit SG&A expense is expected to be $10mm to $20mm higher compared to last year, primarily due to the absence of planned reductions in our reserve for bad debt REDUCED as an offset to $10mm increase in retail SG&A


  • EBIT as a percent of sales is planned to be in the range of 11.4% to 11.6% for the year UNCHANGED
  • This is a slight decrease from last year and is a function of the increased level of investments we’ve described
  • Interest expense is anticipated to increase $25mm to $30mm, largely due to increased borrowings and a higher interest rate relative to last year UNCHANGED
  • FCF is planned to be approximately $400mm for 2012 UNCHANGED

Highlights from the Call:


Investment Highlights:

  • In E-commerce, made enhancements to the website to improve navigation/checkout and increased the selection of merchandise, added to functionality of apps, improved fulfillment
  • Announced partnership with online Men's retailer Bonobos in April
  • In March, re-entered Salt lake city market with a store that had 100+ mobile POS devices, 3X the devices as cash registers.
  • Can see significant increase in speed of POS which provides better service in full line & Rack
  • Saw a favorable response to changes to fashion rewards which were focused on convenience- enrollment in new fashion rewards increase 50% YoY


1Q12 Highlights

  • EPS $0.70 +8% YoY
  • EBIT $280mm +2.9% YoY
  • Total sales +13.7%, Comps +8.5%
  • Nordstrom full line & direct comp +9.3% driven by handbags, women's shoe and men's shoes
  • Full line Comp +5.6% driven by the South and Midwest
  • Direct growth +44.2% YoY
  • Rack total sales grew 19.6% with comps +6.8%
  • Percentage of regular price sales continued to increase in the quarter


Gross Margin: -31 bps due primarily to enhanced customer loyalty program and the impact of free shipping


Retail SG&A: +110mm YoY

  • Half of the increase due to e-commerce growth investments focused on improved selection, convenience and overall service
  • Remaining SG&A attributable to sales growth in new/existing stores


  • Ending inventory per square foot +16% which are aligned with merchandise plans
  • Inventory turn of 5.4X slowed slightly from 2011 inline with expectations but expect improvement throughout the year

Credit Performance

  • Rate of decline improved to 4.7% from 7% a year ago
  • Reduced the reserve for bad debt by $10mm (percent of total 5.2%, down from 6.7% LY)

Share Repurchase:

  • 800K shares in Q1 at avg price of $50.79 for total of $40mm
  • $1.1bn remains in authorization


  • EPS outlook remains unchanged
  • Increase Retail SG&A by $10mm due to increase e-commerce investment spend


  • 2Q: +LSD
  • 3Q: +HSD
  • Full year : +4-6%

Gross Margin:

  • 2Q: -70-90bps
  • 2H: -10 to +10bps
  • Full year: -5-35bps





  • Half of the $110 in expense increase due to stores which achieved percent to sales leverage
  • Retail SG&A deleveraged in the Q

Fashion Rewards:

  • Roughly 1/3 of overall volume done on various tenders
  • Started offering rewards in the rack
  • Still have same program as last year with the anniversary sale (rewards customers can shop early)


  • Guidance implies stronger GM in 2H
  • Believe back half earnings will be stronger than 1H

E-commerce Growth:

  • Strong DD comp increase last year relative to 44% growth in 1Q12

Investment Spending:

  • 2012 saw a step change and accelerating moment in investment spending
  • Expect these investments will help achieve long term goals 


  • Always looking to be most effective with space
  • Continue to find ways to add energy to second and third floors
  • Still working on hiring executive role to head up women's
  • Performance on the whole has been challenging- more modern casual side has been improving


  • Expect to do 50-60% sales increase
  • Company is currently on plan with very good momentum
  • Will continue to be JWN's primary online offset concept

53rd week impact

  • $0.03-$0.05 impact

Brooks Brothers Partnership

  • Big part is them understanding the JWN customer
  • Great relationship so far with promising early read

Anniversary Sale:

  • Always want to start the event on a Friday
  • Eventually the event gets pulled back a week due to timing
  • Nothing unusual driving the move

Inventory turns:

  • Slowdown was built into the plan as it relates to new stores and growth in direct
  • Position last year had greater turns

POS device Functionality

  • Functionality is currently at ~75%, will reach 100% by the end of the year
  • Will rollout more in 4Q
  • Planning an additional larger rollout in 1Q13 once POS devices hit full functionality


  • JWN focused on serving customers on their terms
  • Now and going forward, how customers define service, continues to change
  • Making a lot of investments in capabilities around those areas and see good opportunity to build on capabilities and serve customers on their terms

Rack Profitability:

  • Rack continues to be a terrific opportunity to deploy capital
  • Will continue to grow at 15 stores a year
  • Are seeing no deterioration in the stores that have been opened


  • Growth of 44%
  • If growth remains on track, could increased SG&A spend continue into 2013
  • Opportunity capture a lot more customers and continue to grow
  • A lot of the capabilities needed to enhance e-commerce requires more of the right people which is happening now
  • SG&A beyond 1H12 should be a slow growth rate than current due to hiring happening no

1Q Gross margin -30bps

  • Merchandise margin was roughly flat to last year
  • Predominantly related to fashion rewards and free shipping

Rack Concept:

  • Synergy between rack and full line stores
  • Continue to see a healthy relationship between the two formats- beneficial to both
  • Continues to be customer movement back and fourth between full line and nearby rack

Inventory on hand

  • Inventories will be slightly higher coming out of Q2 because there will be one additional week at the start of Q3 for the anniversary sale 


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