Inflation or not? Where do corporate profits go

One thing is very clear: China delivered us high growth with low inflation.

The 1990s was typified by the massive productivity gains of the internet and rapid digitization of information and media. It delivered strong growth with mild inflation.
The 2000s was typified as the coming of China. Profits were made on the falling manufacturing costs provided by the Chinese factories. Chinese products are now world class and they are very price aggressive - putting price pressure on Western manufacturers. The day of the $10,000 Chinese car is fast approaching.

That process will continue for some time. And after China, who knows. Africa and the Middle East could be next: both have the same components of cheap labor, raw materials, and limited manufacturing base.

As a result, companies continue to show record profits even as costs of manufacturing rise due to rising costs of oil, steel, and so forth.
Will this continue? Clearly, the recent earnings releases show that companies continue to beat expectations. I haven't seen statistics that say how many companies beat expectations, but my sense is that most companies beat but only by a little (including Oil and related companies). Compared with last year, not many seem to be revising forecasts upwards. Going forward, the question is: to what degree will companies beat expectations? At this point in the business cycle, we are slowing down.

Normally that would mean the time has come to shift investments away from growth cycle dependent stocks. However, China is now in a position of oversupply. They have to sell the excess steel, aluminum, dishwashers, and so forth. They will export more deflation especially as the US economy slows and demand moderates. That is why I went negative on Whirlpool - they won't be able to raise prices if Korean and Chinese makers are dropping prices.

And inflation continues to be an issue. Outsourcing to China & India provided - and continues to provide - a safety valve to stem inflation. Outsourcing jobs is a great way to keep labor costs down.
Today, however, inflation is moving up, as the chart below shows.

The Fed can wait and see if the current surge in inflation will rollover as the US economy moderates. Some would like to suggest that today's inflation actually reflects pre-Bernanke moves. That is, inflation metrics lag actuals - today's inflation is the result of pricing set months ago, just as tomorrow's lower inflation will reflect Bernanke's monetary tightening impact.

Sounds great. Except that forward pricing for raw materials shows continued inflation. And those raw materials costs are working their way into the cost of living and they aren't going down. Airplane companies are rasing prices and will continue to do so, for example. Housing is very expensive and it continues to be unaffordable for most Americans and rents are also going up.

I am looking for companies that can keep the profits and keep th emomentum.