The Effect of Producer Price Index on the Stock Market
Have you ever found yourself asking these questions? “Why have I not seen a significant improvement in my portfolio and profits, even after my long history of investing in the stock market?” “Where did I go wrong?” If you seem to lose more than gain, maybe you should re-evaluate and strengthen your methods in stock valuation. With better assessment skills, you can mitigate risks and avoid trades that turn up little to no profit. As part of stock valuation, traders must know how to undertake fundamental analysis to examine if a stock is worth its stated market value. Aside from the data from the company’s financial statements, you must also economic indicators since they also play a significant role in designating value to stocks.
In this article, we will be focusing on an essential economic indicator that contributes to the fluctuation of stock prices, the Producer Price Index. Especially for beginners in stock investing, we aim to shed light on the correlation between this indicator and the stock market.
Definition of Term: What is Producer Price Index (PPI)?
This term describes the measured average of changes in the wholesale pricing of goods. It is a weighted manifestation of consumer-level price movements and of the corresponding inflated price of goods and services.
Wholesale price index or “finished prices PPI” tracks the production costs across the various levels of manufacturing goods. Depending on PPI data, economists are able to determine the price factors affecting oncoming inflation. Movements in the PPI serve as a signal for banks and other financial institutions to adjust their interest rates accordingly, thus creating a universal effect in the economy’s situation.
The PPI shows changes in the prices of materials in the manufacturing of physical products. This means that it tracks indexes of commodity in the primary production phase. For example, the price of raw fossil fuel like coal and crude oil. It also takes note of price movement for materials used in the second phase, called the stage of processing (SOP) of goods, like metals and processed fuels. Finally, it records the fluctuations of prices of the final products on wholesale. Hence, the computation of PPI is the weighted average of these levels of price indexes.
How is Producer Price Index (PPI) linked to the Stock Market?
Take note that PPI has a considerably direct effect on the prices of goods and services. Hence, this data is a great indicator of inflations and interest rates that increase in the future. As a general rule, additional expenses by the producers are carried by the consumers or else they lose profits. Inflation is a major discouraging factor in the consumers’ purchasing process. When goods and services have higher prices, people buy less, thus producers lose earnings. A significant loss in the revenue of a company would reflect in the financial statements, thus affecting market values.
Increase in PPI suggests an upcoming hike in the prices of consumer goods. Relatively, the decrease in PPI means that goods and services are undervalued. This is an indicator of an economic downturn.
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