Dow Watch: Is Inflation Sneaking Back Into the Picture?

Producer prices rose again in January, but the Dow isn't reacting badly to the news. Could inflation finally be coming back?

Feb 19, 2014 at 12:30PM

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.

The Dow Jones Industrials (DJINDICES:^DJI)looked strong Wednesday morning, only to sink in early afternoon trading -- down 40 points at 12:30 p.m. EST. Yet the longer-term questions that many Dow investors want answers to is when inflation will eventually return and how the Federal Reserve will fight it. Today's report from the Bureau of Labor Statistics shows that an uptick in inflation appears to be a long way away, although some signs of pricing pressure early in the production process are worth noting.

Inflation
No one wants what's happened in Zimbabwe to happen in the U.S. Source: Wikimedia Commons.

Using different calculations
The BLS changed its methodology this month, going from its past categories of finished, intermediate, and crude goods and services to a stage-based system that divides goods into final demand and four stages of intermediate demand. Still, the general idea remains the same, in that the different categories provide a look at prices throughout the production process to give advanced warning of any changes coming up the pipeline.

At the final-demand level, the headline producer price index rose 0.2% in January, bringing its annual increase to 1.2%. Food products and pharmaceuticals climbed substantially, but airfares dropped to offset some of the gains.

Interestingly, though, the impact of the methodology change was to reduce the headline number substantially. The old finished-goods category rose 0.6% in January, with upward contributions again from food and pharma, as well as higher utility costs for electricity and natural gas and rising prices for dairy products.

Are price rises coming?
Most investors don't pay much attention to the intermediate-goods categories, but there, the numbers have picked up somewhat. Processed goods for intermediate demand were up 0.6% on the month, while unprocessed goods climbed 0.9%. Yet for both of those categories, year-over-year moves haven't been troubling at all. Processed goods are up just 0.3% from this time last year, while unprocessed goods are down 0.9%.

Looking at the BLS breakdown, though, there are a couple areas of concern. At two of the four stages of intermediate demand, prices rose by 1%. In general, the price gains were concentrated at areas in which utility-related costs such as electricity and natural gas had the greatest impact. Yet again, year-over-year figures aren't yet at troubling levels.

What this means for investors
Rising prices for natural gas and electricity could help the utility sector, which has rebounded sharply from losses last year that came largely from rising interest rates. The Utilities Sector SPDR (NYSEMKT:XLU) has risen back toward pre-financial crisis levels, with Dominion Resources (NYSE:D) and other utilities posting impressive jumps as demand for their services increases. That gives utilities a greater chance to improve revenue, and it builds arguments for rate increases when they go before regulators in the future. Even hard-hit nuclear-power specialist Exelon (NYSE:EXC) has bounced off its recent lows, as the prospect for rising electricity prices could finally help it overcome challenges from a low price environment and competition from cheap natural gas.

Meanwhile, even though the PPI isn't looking bad now, it's worth keeping your eye on producer-level inflation. Often, you can get advance warning on consumer-price inflation by tracking the PPI.

Don't let inflation scare you
Low inflation has helped the market rise over the past five years, rewarding those who were willing to take the risk of investing in stocks. Those who stayed out of the market, by contrast, have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Dominion Resources and Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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