What Is The Producer Price Index And How Does It Impact Stocks?

Key Takeaways

• The Producer Price Index measures the cost of goods from the producers’ perspective.
• Higher PPI numbers signify higher inflation, which could lead to interest rate hikes.
• The stock market usually reacts negatively to high PPI reports, but this can change based on all other current economic data.

The Producer Price Index is a key economic indicator that measures changes in prices across different sectors and can help represent shifting trends in particular industries from the producer’s perspective. Here is what the Producer Price Index is, how it is calculated, and how it can positively or negatively impact the stock market.

Producer Price Index

The Producer Price Index (PPI) is a monthly report focusing on the producer level’s cost of goods and services. It measures inflation or deflation for the previous month and provides a year-over-year comparison. The report is usually released the second full week of the following month and is a leading indicator of economic trends. In other words, the PPI is a predictor of what may show up in the economy in the coming months.

The PPI is a weighted index, meaning it gives more weight to some items and less weight to others based on the dollar value used by each industry and final user. These dollar values are converted to percentages and sum them to 100 percent for each group. This methodology is used to create the most accurate picture possible of the importance of a product to the economy. The index issues numbers both including and excluding variables like energy, trade services, and food. Taking these weights out can affect economists’ readings of the index, and their opinions on the overall state of inflation or deflation.

The calculation of the Producer Price Index uses a base of 100, making it easier to calculate. For example, an index level of 115 means a 15% price increase since the base period. If the reading were 85, that would indicate a 15% price decrease since the base period. Reports mainly use three PPI classification structures: commodity classification, industry classification, and final demand-intermediate demand.

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The PPI is also used to predict the Consumer Price Index (CPI). The CPI represents the average cost of a basket of goods purchased by consumers to meet their needs. The CPI is a lagging indicator because the PPI has reported the same information at the producer level. However, the PPI produces pricing information for products that haven’t reached the market or the consumer. The data relayed by the PPI is accurate but can only provide insight into what may happen to the economy, so what is suggested may not always come to fruition.

How PPI impacts the stock market

Inflation is a normal part of the economy as costs tend to rise over time. A bushel of apples that cost $0.10 in 1922 is now priced at $5 or more due to inflation. A bit of inflation year-over-year is expected and usually doesn’t cause a stock market panic. The Federal Reserve aims to keep inflation around 2% annually.

The stock market typically reacts negatively to the PPI when inflation spikes more than a few tenths of a percent. The opposite is true when the PPI shows deflation. In the current economic environment, the stock market has rallied even while the PPI report is high, so long as it signals inflation might slow down. However, recently, the Federal Reserve has made it known that it will continue to fight inflation aggressively, so any increases in the PPI can be seen as bad for the stock market. This is because it gives further incentive for the Fed to raise rates.

In general terms, a normal economic cycle may go something like this. Higher-than-normal inflation causes the average price of a basket of goods and fuel to increase over a short period. Consumers react by buying fewer goods and spending less money. Consumers spending less money results in lowered profits for industries across the board. The industries may still be profitable but are at risk of slower growth and are more likely to lay off employees. As more people lose their jobs, spending slows further, and even those still employed will likely cut back on spending, fearing they, too, might lose their jobs.

As this cycle progresses, the stock market loses confidence in a company’s ability to deliver profits and growth and sells off stocks. A stock sell-off causes shares to lose value and, by extension, the company losing value.

Eventually, the cycle gets to a point where the Federal Reserve must begin to lower interest rates. This rallies the stock market, businesses slowly hire, and people start spending money again.

Current PPI report analysis

For November 2022, the PPI shows that the overall final demand rose by 0.3%. That’s on top of increases of 0.3% in October and September. The PPI increased by 7.4% between November 2021 and November 2022. About one-third of the November increase was attributed to a rise in prices for financial services — like securities brokerage and investment advice — that totaled 11.3%, with indexes for machinery and vehicle wholesaling and related services also increasing. Prices for passenger transportation fell by 5.6%. Indexes for automobile and automobile parts retailing also decreased.

Prices for final demand without foods, energy, and trade services rose 0.3% and increased 4.9% year-over-year. Final demand for goods increased by 0.1%, and the final demand for services was up by 0.4%.

Bottom Line

The Producer Price Index is an essential economic report many economists and the Federal Reserve use to predict the economy’s future. But it is not the only one. To fully understand the economy’s direction, you should review all economic data before coming to a conclusion. Still, the PPI report contains valuable insight into what is happening to prices at the producer level, which can be tracked up to when they reach consumers in the form of the CPI report.

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