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