PPI inflation is a risk for businesses. Look at the latest numbers.

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Profit margins could decline if companies cannot pass increased costs on to consumers.

Alex Wong / Getty Images

Like consumers, businesses pay higher prices for goods and services, a risk to profits in 2022, if businesses cannot pass the costs on to their customers.

On Thursday, the producer price index, or PPI, rose 9.7% year-over-year in December. It’s the highest reading on record, but it was a little better than the 9.8% economists were expecting. Producer prices excluding food and energy rose 8.3% year on year for December. It was a little worse than the 8% economists expected.

The stock market does not do much in response to the data, as the PPI release is usually not an evolving market event. Nonetheless, it matters to investors, although the effects of a rising PPI on stocks may take some time to materialize.

The PPI is essentially the commercial version of the Consumer Price Index, or CPI. It measures the evolution of the prices of goods as they leave the factory. And recent PPI readings are another reminder that inflation is on the rise.

The CPI, of course, rose 7% year-on-year in December, the Labor Department reported on Wednesday. This is the highest rate since the early 1980s and up from the 6.8% increase reported in November.

Stocks actually rose on Wednesday’s inflation announcement, with respective gains of 0.3% and 0.1% for the


S&P 500

and


Dow Jones Industrial Average.

The yield on the 10-year Treasury bill was largely unchanged, possibly because the inflation reading was in line with expectations.

The PPI reading was also roughly as expected. This is another reason for the moderate market reaction on Thursday.

But rising prices for companies threaten profit margins. And evidence of declining profit margins will be one of the most important things to watch for when companies start releasing fourth-quarter numbers – and forecasting 2022 – in the coming weeks.

About 110 S&P 500 companies are expected to report earnings in the next two weeks.

In recent times, the expansion of the profit margin has strongly boosted profit growth. Operating profit margins for S&P 500 companies are around 15% on average, up from pre-pandemic levels of around 13%.

Maintaining such high margins will be a challenge for businesses in 2022. Just as balancing household budgets will be a big challenge for regular consumers.

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