Inflation Fears Send the Dow Downward; Should Caterpillar and Nike be Climbing?

After two record highs this week, the Dow Jones Industrials (DJINDICES: ^DJI  ) had fallen 51 points as of 11 a.m. EDT. Although two major Dow components will report earnings in the next 24 hours, first-quarter earnings season has largely come to a close for the stock market, which means economic data reports are getting more attention from investors. Today's Producer Price Index report pointed to unexpectedly high price increases at the wholesale level, yet despite what seemed like good news for Caterpillar (NYSE: CAT  ) and Nike (NYSE: NKE  ) , their stock prices and the Dow generally didn't react favorably to the report.


Source: Caterpillar.

Is inflation back?
The Producer Price Index rose 0.6% in April, following a 0.5% increase in March. The two-month gain finally pushed the overall inflation level over the past 12 months to 2.1%, the first time in more than a year that the figure has exceeded the Federal Reserve's 2% target for inflation. Unlike last month, in which rising prices for services were the dominant factor in the overall increase, April's figures included an equal 0.6% increase for both goods and services at the final-demand level.

Digging into the report, energy prices continued to hold back inflation, with a rise of just 0.1%. But food prices soared 2.7%, with an over 8% jump in meat prices accounting for fully a third of the overall increase in final-demand goods. On the services side, margins for wholesale machinery and equipment providers rose 2.7% as well, and retailing of apparel, footwear, and accessories was also an important factor in pushing the services price index higher.

Those figures would appear to support the businesses of Dow Jones Industrials components Caterpillar and Nike. If retailers of machinery and equipment that Caterpillar supplies are producing higher margins, then Caterpillar should in turn be able to raise its wholesale prices in supplying those goods, capturing part of the retailers' higher profits. Moreover, even though the price increases are occurring on the services side, they nevertheless suggest rising demand that should eventually filter through to greater sales for Caterpillar.

Source: Nike.

Similarly, Nike relies on pricing power in setting retail prices for its athletic shoes and apparel. If retailers are earning more profits from selling Nike's goods, then Nike will be in a position to boost the prices it charges those retailers on the wholesale end. That's good news for Nike, although it could eventually lead to higher prices for consumers at the retail-inflation level if those retailers pass through their higher costs to their customers.

Yet both Caterpillar and Nike are actually down today. Investors in both Dow components will want to see further evidence of rising prices -- as well as assurances that their own cost structures won't lead to reduced margins -- before they reward those stocks with counter-trend share-price increases.

Why inflation isn't a worry -- yet
Looking further down the supply chain, price pressures appear largely limited to unprocessed goods. Raw materials such as foodstuffs, crude oil, and carbon-steel scrap have contributed to a year-over-year 6.5% increase in prices for unprocessed goods. But on the processed-goods side of the equation, prices have only risen 1.5% in the past year, as prices of gasoline and other diesel fuel have remained much more stable.

Overall, inflation isn't a threat to the Dow Jones Industrials yet, as even at the wholesale level price increases in certain goods and services haven't filtered through to the overall economy. In the long run, though, many economists worry that the Federal Reserve's long period of low interest rates could eventually produce substantial inflation. Policymakers and investors alike must remain alert to signs of inflation rising up through the Producer Price Index that could eventually have an impact on consumers and on the Dow Jones Industrial Average.

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