Opinion: A more accurate inflation indicator is painting a bleaker picture for rising prices
Every month, investors wait with a din for the release of the consumer price index, the headline metric that politicians and experts quote when they judge inflation.
The May CPI report, released June 10, gave these experts much to discuss. Prices rose 5% in one year, the largest increase since 2008.
But I always tell customers to use the CPI with caution. It’s the headline number, and it might get the story right right, but there are too many components in the index that don’t reflect the experiences of typical consumers.
Read: Don’t be fooled – inflation is a huge risk for stock market investors. So prepare yourself
That makes it a less useful measure of inflation than you might think. At the same time, there is another indicator that investors and consumers should examine carefully. This picture is even more disturbing.
What can be seen
Of course, some CPI metrics tell the real story. For example, the prices for used cars and trucks rose by almost 30%, while the prices for new cars only rose by 3.3%. This is important. When used car prices soar, they have an overwhelming impact on the economic health of some consumers.
Interestingly, the markets overall appeared unimpressed by the report. This could indicate that inflation worries are subsiding or are already anchored in investor expectations. There was no knee-jerk stock sell-off like there was in April. The bond markets’ reaction was curious as the 10-year TMUBMUSD10Y, 1.467% yield, closed 3 basis points lower after falling 13 basis points last week.
Does that really mean the inflation fear is over? A closer look at the producer price index suggests the opposite.
This lesser-known government indicator could be a better metric for determining whether we are moving into an inflationary environment. Unfortunately for consumers and investors alike, the PPI shows even more warning signs than its CPI brethren.
The PPI tracks domestic production of goods and services and captures the price pressures producers see from their suppliers, which in turn is passed on to consumers.
In the April PPI report, final demand – the prices received by manufacturers on the last sale – rose 6.2%, the highest increase since the Bureau of Labor Statistics began calculating and reporting annual data in November 2010.
Even more alarming
If you look further up the supply chain, the latest PPI seems even more alarming. Consider the component of the index that measures the prices of manufactured goods for intermediate demand. This category includes materials for food production, construction, and durable and long-lasting manufacture.
April’s PPI report shows that this component is up 18.4% over the same period in 2021. This was the largest annual increase since February 1980. So while the CPI surge has reached levels not seen since the Great Recession, this crucial component of the PPI is rising at prices that have not been touched in over 40 years.
As this report shows, prices for goods in the supply chain have been rising for five months. In each subsequent period the climbs have become steeper. In March, the prices of processed goods for intermediate consumption rose by 12.5%, after monthly increases of 6.6% in February, 3.1% in January and 1.5% in December 2020.
In contrast, in 2020, the prices for processed goods for intermediate consumption declined every other month from November to January.
The big Fed debate
There is a popular debate about whether we are heading for an inflation period or whether we are already in one. If the answer to any of these questions is yes, how long will it take?
The Federal Reserve’s line remains that all inflation will be temporary. There is widespread concern in the business world that this may not be the case. If you’ve listened over and over to the executives on the recent corporate earnings conference call, they have raised the alarm in the face of inflation. They say they managed to keep prices down by hedging their raw material costs over the past year, but add that they may need to raise prices. How long will it be before these costs are passed on to the consumer when the PPI shows rising commodity prices?
When looking at PPI data, it is hard to avoid the conclusion that inflation may already be imminent and that the final cost could continue to rise in response to the dramatic rise in intermediate costs.
How long it will take? A number of factors could answer this, including continued government stimulus and whether supply from chips to workers will catch up with consumer and business demand.
I don’t believe in the fight against the Fed. And I don’t want to get out of the markets. But I feel that any risk-balanced approach to investing in the current environment must consider the possibility that inflation is already above us and may be deeper into the economy than the CPI suggests.
Brian Lasher is Vice President of Asset Management at CIG Capital Advisors, where he is responsible for the company’s investment strategy.