When investors talk about the stability of the markets, one of the most common indicators they look to is the Consumer Price Index (or CPI), which is calculated and released monthly. The CPI is a tool that allows investors to assess, well, other investors. In fact, the number actually gives us a greater understanding of a large portion of Americans and their ability to afford basic goods. Essentially, the CPI shows the average cost of living for Americans by calculating the average prices of commonly used consumer goods. However, because the Index is calculated monthly, the prices of these goods can change over time. By tracking the same “basket” of goods each time and averaging their changing prices every month, then, the CPI can show investors any potential periods of inflation or deflation as markets change over time.
One of the most common questions that investors ask in relation to the CPI is, how can one number indicate the cost of living relative to so many different Americans? Well, in reality, two types of CPIs are reported each time the numbers are released: the CPI-W, which measures the CPI relative to Urban Wage Earners and Clerical Workers, and the CPI-U, which measures the CPI for Urban Consumers. Basically, almost 90% of the American population is filtered into one of these groups – which include professional workers, wage workers, retired people, and unemployed people. Essentially, the thought is that, even if you are not currently employed, it is still likely that you regularly consume goods in the markets. So, both of these groups are assessed based on their ability to purchase goods in the markets, allowing the CPI numbers to encompass a large portion of the American population.
Similarly, basic categories of goods that are considered in the CPI calculations are items that one would typically expect many Americans to consumers regularly. For example, some of the main categories that are taken into consideration for each calculation of the CPI are items such as food, housing, apparel, transportation, medical care, education, and recreation. Thus, the number is thought to be applicable to a large majority of Americans on the basis of the goods considered, as well.
So, knowing that the CPI can give us more insight into the ability of the American population to purchase typical consumer goods, we can then turn to the question of how it can indicate inflation. For the sake of argument, let’s consider the typical inflation threshold that the United States aims to meet, or 2% inflation per year. This “target” inflation rate represents the percentage increases in the prices of goods that we would expect to see in that year. Of course, this target inflation rate can directly be linked to the CPI, which tracks the increases or decreases in the prices of that “basic basket” of goods each month. Thus, from looking at the CPI over time, one might be able to get a sense of whether national inflation is “on the right track” or not.
From this kind of analysis, investors can take away many inferences about the markets. For example, if the CPI shows the costs of basic goods increasing significantly over time, investors may be wary of inflation and consider investing in assets that are typically “safer” from inflation. One example of such assets as stocks, which have typically been resistant to inflation over time. Further, if long-term deflation becomes a threat to investors, many investors might consider turning to other forms of assets, such as bonds, which typically fall in price less quickly than stocks do during periods of deflation.
Ultimately, the optimal course of action for many investors might be to follow the CPI each month and determine how they affect the prices of stocks in the markets. By understanding key indicators such as the CPI, investors can better prepare themselves to make more informed investment decisions.