Alroy Commentary - Understand Price Indicators and Impacts to Equity Markets
Price level is one of the red-hot economic indicators that investors and market are eager to know. The rational behind is easy to understand: Consumers would like to know how prices change is eroding their purchasing power, and the corporations would like to use the data for pricing strategy.
Normally inflation is not a problem at the beginning of business cycle. Companies cut their production scales during recession due to lack of demand. As a result, there are enough idle resources and capacity for companies to expand without taking too much price pressure after recession, when the demand is picking up. Inflation appears at the middle to end of the business cycle. At that moment, resources and materials become scare and companies compete the supply by bidding up the prices.
There are two major price indicators, namely Consumer Price Index (CPI) and Producer Price Index (PPI), to measure to movement of general price level. The components in both indices are different county by country.
For example, Consumer Price Index in U.S. comprises of pricing in different areas such as food and beverages, medical, transportation and recreation etc. This figure can reflect the actual cost of living of US residents. Sometimes investors refer to so called Core CPI, which is CPI excludes energy cost and food cost. It is because both components are quite volatile under temporary factors such as crop failures and oil supplies and may distort the CPI figure.
Producer Price Index measures changes in prices that manufacturers and wholesalers pay for goods during various stage of production. Investors always believe the change in PPI will affect the CPI, as higher production cost will result higher selling prices to consumers. However it is not always true. In fact, according to the historical data, only PPI finished goods (One of the components in PPI) could affect the CPI, as both figures mainly focus on consumer goods rather than raw materials.
Generally speaking, equities perform better during inflation is in silence rather than existence. Higher inflation may force central banks to raise interest rate, which may slow down the economic growth and hurt the profitability of corporations.
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