Producer Price Index – PPI – What is the Producer Price Index?
The Producer Price Index (PPI) is an indicator of the change of prices received by producers for their products. Or put another way, the change in how much retailers pay for the products that will be sold to the consumer.
Recall that the more famous Consumer Price Index (CPI) measures the change in prices as experienced by the consumer. The PPI tells us the change in how much producers are selling those products to retailers.
As of February 2014, the Producer Price Index – PPI – has been expanded to include the effects of price changes in more service and construction sectors. As the U.S. economy has become less manufacturing based and more serviced based, the “old” PPI calculation was not representative of the economy.
The PPI takes into account output prices from the mining, manufacturing, agriculture, fishing, forestry, natural gas, electricity and construction industries. In total, the Bureau of Labor and Statistics (BLS), who publishes the index, claims that the PPI represents prices in over 75% of “in-scope domestic production”.
Producer Price Index Release
The PPI is released at 8:30 am Eastern Time in the second or third week of the month. For a listing of schedule PPI releases, see the Bureau of Labor and Statistic’s calendar here: http://www.bls.gov/schedule/news_release/ppi.htm
The latest release can always be found here: http://www.bls.gov/news.release/pdf/ppi.pdf
The highlight of the report, and the number you will see breaking on financial news websites is the headline number. The headline number is the increase (or decrease) in the total price change for finished goods.
Here, the headline number is highlighted. This headline number tells investors that on average, prices increased 0.4% for finished goods in December 2013.
But the report tells investors much more information than that, in total the report is around 200 pages long. The Producer Price Release gives data on price changes for three main categories of products;
Finished – Products ready to sell to the consumer without further processing. Think apparel, automobiles, furniture, heating oil, etc.
Intermediate – Products that have been processed, but require further processing before being purchased by the consumer. Intermediate products include woven cotton and yarn, leather, cut and treated lumber, diesel fuel, etc.
Crude – Products that have not been processed and are not sold directly to the public. Crude products include raw cotton, animal hides, raw lumber, crude oil, etc.
The BLS also publishes a “Core” PPI reading, which excludes volatile items such as food and fuel costs in order to reduce instability in the PPI number.
The report publishes very specific data on price changes in specific sectors. Nearly every significant product to the U.S. economy is represented. Consider this page shown below, just one of the more than 130 pages like it in the report:
Using the Producer Price Index – PPI
The data within the Producer Price Index release is vast, how do investors use it?
The PPI is seen as a leading indicator as it can identify price changes in the economy before other reports on consumer spending or the Consumer Price Release.
For example, as prices for processed cotton increase, the magnitude of that change would be identified within the PPI release before the price increase reaches the consumer (in the form of finished shirts) and is reported in the CPI.
The Producer Price Index can also be a leading indicator on companies’ margins. As prices increase for producers, they have a choice of either; 1) passing on the increase to consumers, and therefore maintaining margins or, 2) not raising their prices, and thereby getting less money for their products, reducing their margins.
Or as prices decline, they may choose to keep their prices steady, which in turn will cause an increase in their margins.
Using the PPI and CPI together can give investors an insight on the conditions of the market. In tough times, such as recessions, producers may be less likely to pass on price increases to its customers and therefore margins may contract. If price increases are being passed on to consumers, investors can expect company margins to remain relatively stable, or improve. A company’s margins are a primary factor in its earnings, so having a clue on what a company’s margins will be is a significant advantage.
The PPI can be volatile. For that reason economists usually look for a trend in the data instead of just one month’s worth of data.
Economists may look for prices to remain climbing for 3+ months in a row before making decisions based on the data, as one month’s data may vary significantly from the next if certain components had major price changes.
The BLS publishes a “Handbook of Methods”, which describes the history, make up and uses of the PPI here:
Also, the last pages in any PPI release explains a lot of terms within the report and some of the method to constructing the index.
The Producer Price Index is also featured in The WSJ Guide to the 50 Economic Indicators That Really Matter. A fun read for investors curious on how to use the PPI data further, and investments that make since when it is increasing and decreasing.
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