At 4am on February 15th, 1996, after sitting alone in a room writing out lyrics since 6pm, Bob Dylan called his studio musicians in to record what turned out to be one of his greatest masterpieces.
Dylan was in Nashville, having left New York the previous year. He had been frustrated with the slow progress recording his next record. So at the suggestion of his producer, he took guitarist (and fellow Canadian) Robbie Robertson and keyboardist Al Kooper down to Nashville, and along with a host of session players, set about recording Blonde on Blonde.
For the non-Dylan fans, most of you will be familiar with first track of this album. Rainy Day Women #12 & 35, or as you might know it “Everyone must be get stoned”, is an iconic overplayed Dylan tune. Yet the rest of the album is pure genius, with track after track of classic Dylan at his best.
Although there are loads of great songs on this album, the last track he recorded that February morning was in another league. I have trouble committing to my favourite Dylan tunes, but I have to put this in the top three.
My favourite part of this story happened during the recording of this song. Emerging from a room after ten hours of working on the lyrics, Dylan called together the musicians to record the song. They started playing. At this point they had not heard the lyrics. As they were recording, they played a couple of verses and were building for a big ending, but the lyrics kept coming… and coming… and coming….
The session drummer later recalled:
“If you notice that record, that thing after like the second chorus starts building and building like crazy, and everybody’s just peaking it up ’cause we thought, Man, this is it…This is gonna be the last chorus and we’ve gotta put everything into it we can. And he played another harmonica solo and went back down to another verse and the dynamics had to drop back down to a verse kind of feel…After about ten minutes of this thing we’re cracking up at each other, at what we were doing. I mean, we peaked five minutes ago. Where do we go from here?”
The song was of course, Sad Lady of Lowlands and it ended up taking the entire fourth side of the album. It clocked in at 11 minutes and 19 seconds. It was way too long to ever become a big hit, but for Dylan fans it ends up being one of his best.
I can think about no better analogy for the markets than this great Dylan tune. As I sit day after day, watching the market shrug off everything that is thrown at it, all I can do is wonder will it ever end? And at this point, I feel a little like Dylan’s drummer cracking up with the idea, “where do we go from here?”
There are lots of smug bulls suffering from a severe case of overconfidence due to the relentless rise of the past seven years. These bulls are quick to point out that there is no alternative to stocks, and that you are foolish to even think about not being long.
Yet I think we have hit the point in psychology where markets are immune to fundamentals. They rise because they are rising. I know that sounds stupid, but I am a big believer in Soros’ theory of reflexivity. As an asset rises in price, instead of demand decreasing as would be expected, more investors become confident in its investment merits. Therefore instead of demand being a downward sloping curve, it can actually be upward sloping. It is possible to get more demand as prices increase.
This is what I believe is happening now. It is made all the worse by Central Banks who are insanely monetizing their balance sheets by buying S&P 500 futures. The fact that these Central Banks are not price sensitive is causing the market to rise irrespective of fundamentals, which is only encouraging more bulls who are attracted to the price action.
However, eventually Soros’ reflexivity bubbles collapse in on themselves. There are increasing signs that the stock market fundamentals are severely stretched.
Have a look at this great chart from Doug Short that illustrates the adjusted P/E against the last 10 years of earnings:
Or this even better chart that shows the median price/earnings multiple for US stocks over the past 60 years:
Here is a similar series that shows median stock cash flow multiple:
I know that we could pick some different graphs that show on a relative basis, the stock market is still cheap when compared to the alternatives. Many of the bulls are hanging their hats on these sorts of metrics.
And I guess if you think that these sorts of zero and negative rates will last forever, then maybe this sort of analysis makes sense.
But I don’t think that investing in the stock market at all time high valuations makes sense just because some Central Banks are quantitative easing financial asset prices into the stratosphere.
I am aware that this bull market seems to have taken a life of its own. As I try to imagine how it might end, I try to remember back to 1999. Back then there were also many famous investors that were preaching caution, yet the market kept rising irrespective of their warnings. Warren Buffett was labelled an out of touch old codger. I dug up this 1999 article from Barrons:
After more than 30 years of unrivaled investment success, Warren Buffett may be losing his magic touch.
Shares in Buffett’s Berkshire Hathaway are set to experience their first annual decline since 1990 and their second-worst year of performance, relative to the Standard & Poor’s 500 Index, since Buffett took control of what had been a struggling New England textile maker in 1965.
But there’s more to Berkshire’s weak showing than just the operating and investment performance. To be blunt, Buffett, who turns 70 in 2000, is viewed by an increasing number of investors as too conservative, even passe. Buffett, Berkshire’s chairman and chief executive, may be the world’s greatest investor, but he hasn’t anticipated or capitalized on the boom in technology stocks in the past few years.
And it wasn’t just Buffett. Famed investor Julian Robertson quit at the height of the tech bubble because he felt the markets had become completely irrational. And Druckenmiller and Soros both had trouble navigating the final stages of the tech bubble:
“Maybe I don’t understand the market,” a reflective Mr. Soros said at the April 28 news conference. “Maybe the music has stopped, but people are still dancing.”
When I think about today’s market I realized that no one big has thrown in the towel yet. There has been no high profile manager quitting because he doesn’t understand the markets anymore. There are no articles about how Buffett has lost his touch.
In 1999 and 2000 the market was completely and utterly irrational. Idiots like Cramer went on TV and told you how these famed veterans “didn’t get it.” How they were going to miss all the new wealth.
Of course we all look back at this time and make fun of Cramer, not Buffett. But don’t ever forget that the majority thought Cramer was right back then. Just like today the majority think that this Central Bank fuelled insanity is normal and healthy. It isn’t. Not by a long shot. It will end badly. The only question is how stupid it gets before it does…
In the mean time, the song just keeps playing and playing. And although Sad Lady of the Lowlands is a terrific tune, like all things, it eventually comes to an end.