20) Economic Indicators: Producer Price Index (PPI)

by · October 16, 2010

What It Is

The Producer Price Index (PPI) is an index released monthly from the Bureau of Labor Statistics (BLS) and is a weighted index of prices measured at both wholesale and producer levels, including all physical goods-producing industries with the exception of imports. The PPI reveals trends in the manufacturing industries, wholesale and commodities markets.

Basic Information

The PPI report has three headline index figures:

1.    PPI Commodity Index (crude) – Shows average price changes of commodities, such as steel, crude oil or coal, from the previous month.

2.    PPI Stage of Processing (SOP) Index (intermediate) – Goods here are not yet end-products and will be sold further to other manufacturers who will produce the finished goods. Examples of SOP goods are cotton or diesel fuel.

3.    PPI Industry Index (finished) – Final stage manufactured goods. This is the core source of the PPI.
The finished goods index is the main “selling point” of the PPI, but excluding food and energy components because of their volatility. The PPI percentage change from the previous period and yearly projected rates are the most sought out figures of the report.
Information on service-based industries are now covered by the PPI, where it used to be exclusive on “physical goods”. Examples of these industries are couriers, healthcare providers, and air and freight travel.

How the Report Is Valuable

One trait of the PPI which is highly valued by investors is its inherent ability to predict the CPI. This is because the CPI is an indicator for inflation. With the PPI data, investors can have a look in advance of what the market has in store for them. The Fed also makes heavy use of the PPI data as a basis for future policies that have to be made to counter inflation.

Be aware that the PPI does not represent prices at the consumer level. It uses a benchmark year in which a “basket of goods” was measured, and each year onwards is compared to the base year with a value of 100. Right now the comparison year is 1982.

PPI index data for capital equipment is used to compute for the GDP deflator by the Department of Commerce.

It is important to note that the PPI data is presented with and without seasonal adjustments. However, volatile elements can easily skew the data. Despite this, it can still have a positive influence on the markets.

Things to Watch Out For

There are two disadvantages to the “basket goods” approach used by the PPI. First, it makes use of relative weightings for different industries. This may not correctly represent its proportion to real GDP, even if the weightings are adjusted every few years. The second point is that PPI computations include an explicit “quality adjustment method” (also called hedonic adjustments). This method accounts for any change that happens in the quality and usefulness of products over a span of time. However, it may not be able to separate quality adjustments from price level changes accurately.

 

The PPI looks to capture only the prices that are being paid during the survey month itself. This means future values or contract rates are not included in the report. Take note that the exclusion of food and energy prices from the report can be critical if not considered, in that if these two important items grow faster than the core PPI, consumers and GDP will both suffer over time.

Figures in the PPI can be misleading. That is why it is always best represented as a percentage, since a slight change can make the base number no longer an even 100.

The PPI, because of its ability to predict the CPI and as such, inflation, is watched closely by both investors and the Feds. It can be a big influence to the market. It is also very useful for investors for analyzing potential sales and earnings trends in industries the report covers.

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