We created the Doom Index to sound the alarm ahead of the next crisis. It tracks 12 key indicators to detect when there’s stress in the economy and markets are overheating.
[For more information on how we calculate the Doom Index reading each quarter, have a look at our Introducing the Doom Index report.]
The chart below shows our Doom Index levels by quarter. The red bars indicate a reading of 8 or higher. That’s when we raise our “crash alert” flag and tell investors it’s time to prepare for a market crash.
The last time we raised our “crash alert” flag was at the end of Q2 2019, when the Doom Index hit 8. We stayed in the “Danger Zone” for the next four quarters, with the reading hitting 9 at the end of Q3 2019 and staying at that level for the next three quarters.
Economic conditions have improved slightly in the last two quarters, as evidenced by our Doom Index reading dropping to 7 in Q3 2020…
Our recent Doom Index reading – based on the Q4 2020 data – is 7.
We continue to see a massive split between Wall Street and Main Street.
Stock valuations are at all-time highs. But as stocks soar higher, small businesses continue to struggle. And millions of Americans continue to receive unemployment benefits.
Below, we’ll break down what we found when we looked under the hood. The good… and the bad.
The Good News
The Institute for Supply Management (ISM) Manufacturing Index is a great indicator of economic activity. A reading above 50 signals expansion. The reading came in at 60.7 in the fourth quarter. No Doom Points were awarded.
U.S. Railcar Utilization tells us the amount of goods moving throughout the economy. When railcar utilization falls, it indicates that economic activity is slowing down. Utilization was flat in Q4 when compared to the previous quarter. No Doom Points were awarded.
Junk Bonds are the riskiest bonds for sale on the open market. We follow the iShares iBoxx High Yield Corporate Bond ETF (HYG), which tracks movement in the junk bond market.
We award one Doom Point whenever HYG trades down for the quarter, meaning the ratings agencies see a greater risk of default for junk bonds. HYG was up 4.1% last quarter. No Doom Points were awarded.
Additionally, Nonfarm Payroll and U.S. Building permits increased in the fourth quarter. They were up 1.5% and 8.5% respectively. No Doom Points were awarded.
Finally, Margin Debt Outstanding tells us how much leverage investors are using. It’s a good contrarian indicator. We award one Doom Point whenever it exceeds 3%.
In Q4 2020, margin debt was at 1.9%. Investors were borrowing at sustainable levels last quarter. No Doom Points were awarded.
The Bad News
Stock Valuations
All three of the stock market valuations we use for the Doom Index signaled that the stock market is overvalued:
The Shiller P/E Ratio – also known as the cyclically adjusted price-to-earnings (or CAPE) ratio – compares stock prices to their average inflation-adjusted earnings over the past 10 years.
The long-term average – over 140 years – is 17. We award one Doom Point when the Shiller P/E ratio is above 24.
In Q4 2020, the Shiller P/E ratio was 34.04
Doom Points awarded: 1
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The Buffett Indicator compares the market capitalization of all U.S. stocks to GDP. Renowned investor Warren Buffett says the indicator is “probably the best single measure of where valuations stand at any given moment.”
We award one Doom Point when the ratio tops 1.
The feds are printing trillions of dollars, pushing stock prices higher.
But U.S. GDP continues to lag behind as the Main Street economy continues to struggle.
These two forces are pushing the Buffett Indicator higher and higher. It hit 1.83 at the end of Q4 2020, an all-time high.
Doom Points awarded: 1
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Tobin’s q Ratio compares the market value of 5,000 U.S. stocks to the replacement cost of their assets. Then, it looks at where the stock price is relative to those replacement costs. It’s a great way to compare stock prices to something tangible.
We award one Doom Point when Tobin’s q Ratio tops 1. The Q4 2020 ratio is at 2.3, the highest level we’ve seen since 2001… just before the dotcom bubble burst.
Doom Points awarded: 1
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Another metric we look at is U.S. Investor Sentiment. It tells us what investors think will happen in the markets over the next six months. We use this as a contrarian indicator.
We award one Doom Point whenever more than 45% of investors are bullish on the markets for the next six months.
Investor Sentiment came in at 46.1% last quarter.
Doom Points awarded: 1
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Bank Loan Growth tracks commercial and industrial loans. When bank loans are growing, it’s a sign that businesses are borrowing money and expanding.
We award one Doom Point whenever total credit growth falls below 2%. We award two Doom Points whenever credit growth is negative.
In the fourth quarter, credit growth declined by 22%.
Doom Points awarded: 2
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Corporate Bond Downgrades tracks the number of corporate bonds downgraded relative to the number upgraded each quarter. We award one Doom Point whenever downgrades exceed upgrades.
In the fourth quarter, there were 60% more downgrades than upgrades.
Doom Points awarded: 1
Total Doom Points awarded based on Q4 2020 data: 7