Why Flat Producer Prices Should Be Good for the Dow

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks have extended their losses in early afternoon trading today, with the Dow Jones Industrials (DJINDICES: ^DJI  ) down about 85 points as of 12:15 p.m. EDT. Lately investors have been most concerned with the Federal Reserve and the massive uncertainty about how it will scale back its highly accommodative monetary policy in the future.

With the economic recovery having been relatively sluggish, inflation hasn't been a major threat. Yet in recent months, rises in the Producer Price Index have raised some concerns about whether wholesale-level price increases would work their way into what consumers have to pay. At least this month, though, those fears appear to have abated, giving the Fed more room to implement a flexible policy course for the future.

What the latest PPI report said
July's report showed that prices for finished wholesale goods were unchanged in July -- a welcome respite from increases of 0.8% in June and 0.5% in May. The primary reason why wholesale inflation stayed under control last month was that energy prices fell a modest 0.2% decline after a jump of nearly 3% in June. In particular, a nearly 4% drop in natural-gas prices and a smaller cut in gasoline costs helped keep the energy component of the finished-goods index under wraps.

Even when you exclude the volatile food and energy segments, core producer prices only gained 0.2%, and the year-over-year core wholesale inflation figure of 1.2% marks the smallest annual increase in nearly three years.

Further down the supply chain, intermediate goods showed the same moderation in price changes: The overall index was also unchanged, while core intermediate-goods prices actually fell. The only remaining inflation concern was at the crude-goods level, where a 10.6% jump in crude petroleum prices and rising coal prices led to a 1.2% jump in overall crude-goods prices for the month, bringing year-over-year price gains to 9.3%.

What the report means for investors
Seeing producer prices stay flat should take some of the pressure off potential inflation at the consumer level. That obviously bodes well for consumers, but it will also help businesses sustain their profit margins without facing the difficult prospect of trying to pass their own higher wholesale costs through to their customers.

But for specific industry niches, some of the price figures are actually encouraging. Rising coal prices, for instance, are likely one reason why coal giants Peabody Energy (NYSE: BTU  ) and CONSOL Energy (NYSE: CNX  ) have posted significant gains after hitting bottom in late June and early July. Much of the demand for coal has come from overseas, and both of these companies have taken advantage: Peabody is using its extensive resources in Australia to meet demand from Asian markets, while CONSOL focuses on exporting more of its U.S. coal. Still, the world markets have an impact on U.S. prices, and the PPI will reflect that.

In general, though, investors should applaud price stability. Once investors understand more clearly what the Fed's intentions are, they'll likely realize that controlled inflation will be helpful in giving policymakers the flexibility they need to manage the recovery more effectively.

Inflation can be your worst nightmare as a long-term investor, but your best strategy involves choosing great companies that have the ability to pass through price increases and still produce strong growth. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well. Click here now to read more.


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