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 tattered crash alert flag and tell investors it’s time to prepare for a market crash.
|
As you can see from the chart above, we raised the “crash alert” flag in Q2 2019, when the index reading moved up to 8. In Q3 2019, it shot up to 9, where it stayed for the next four quarters.
In the first quarter of 2020, the S&P 500 – the bellwether for the American stock market – fell 34%, its fastest drop in history.
Over the summer, the S&P 500 rebounded… hitting new all-time highs, based largely on investor confidence in the feds’ stimulus measures.
Our recent Doom Index reading – based on the Q3 2020 figures and reports – is 7.
Good News
First, the good news…
The Institute for Supply Management (ISM) Manufacturing Index is a terrific gauge of economic activity. A reading above 50 signals expansion. At the end of the third quarter, the reading was at 55.2. So no Doom Points were awarded.
We use U.S. Railcar Utilization as a proxy for the amount of goods moving throughout the economy. When the economy slows, the movement of goods shipped also slows. In Q3, Railcar Utilization was up 45% from the previous quarter. No Doom Points were awarded.
Likewise, Nonfarm Payroll and U.S. Building Permits were also on the rise – up 4.83% and 27.5%, respectively, from the previous quarter. No Doom Points were awarded.
And finally, Investor Sentiment. We use this as a contrarian indicator. Stocks tend to fall when investors get too bullish. We award one Doom Point whenever investor sentiment tops 45%. In Q3, investor sentiment remained low – at 26.24%. No Doom Points were awarded.
Bad News
Now for a look at the indicators that are giving us cause for concern…
Bank Loan Growth tracks the growth and decline of commercial and industrial loans. We award one Doom Point whenever total credit growth falls below 2%. We award two Doom Points whenever credit growth goes negative.
During the third quarter, credit growth declined 20%.
|
Doom Points awarded: 2
***
Corporate Bond Downgrades tracks the number of corporate bond downgrades relative to the number of upgrades each quarter. We award one Doom Point whenever downgrades exceed upgrades.
During the third quarter, there were almost three times as many downgrades as upgrades.
|
Doom Points awarded: 1
***
Margin Debt Outstanding tells us how much borrowed money investors are using. We take the average margin debt for the quarter and divide it by the market cap of the S&P 500. It’s a pretty good contrarian indicator.
We award one Doom Point whenever margin debt exceeds 2%. We award two Doom Points whenever margin debt exceeds 3%.
In the third quarter, margin debt equaled 2.13% of the S&P 500 market cap.
|
Doom Points awarded: 1
***
Stock Valuations
We look at three different stock market valuation ratios, all of which showed that the stock market is overvalued right now:
The Shiller P/E ratio – also known as the cyclically adjusted price-to-earnings (or CAPE) ratio – looks at the price of stocks relative to their average earnings, adjusted for inflation, over the past 10 years. We award one Doom Point whenever the Shiller P/E ratio tops 24.
In Q3 2020, the Shiller P/E ratio was 30.9.
|
Doom Points awarded: 1
***
The Buffett Indicator compares the market value of all U.S. stocks relative to annual GDP. That tells us how much stocks are worth relative to the size of the economy. A reading above 1 tells us stocks are overvalued. We award one Doom Point whenever the Buffett ratio tops 1.
In Q3 2020, the Buffett Indicator was at 2.01.
|
Doom Points awarded: 1
***
The Tobin’s q ratio compares the market value of 5,000 publicly traded companies in the U.S. to the replacement costs of their assets in the private market. Then, it looks at where the stock price is relative to those replacement costs. We award one Doom Point whenever the Tobin’s q ratio tops 1.
In Q3 2020, the Tobin’s q ratio was at 2.1.
|
Doom Points awarded: 1
Total Doom Points awarded in Q3 2020: 7
|