Goldman Sachs is questioning everything it knows about capitalism in the wake of a growing debate over the sustainability of corporate profits.
Profit margins are extremely high, mirroring levels seen before the financial crisis of 2008 and the dot-com bubble at the beginning of the century. Today stock buybacks are also happening at record levels, increasing corporate debt.
The S&P 500 has continued to rise and maintain relatively high valuations despite these trends, prompting a Goldman Sachs analyst letter that questions how capitalism in the world is currently operating. Markets have been essentially rewarding corporations that assume more and more debt through stock buybacks, boosting profit margins, reports Bloomberg.
The issue is one of the hottest debates in the financial sector, with bulls arguing that market performance is not necessarily tied to profit margins, while bears maintain that economic rules dictate a major market adjustment in the near term. Goldman Sachs analyzes both arguments, but tends to agree that bearish arguments will eventually come to fruition.
If the market does not experience an adjustment in profit margins however and valuations continue to stay high, something could be fundamentally wrong with our current system of capitalism according to Goldman analysts.
Profit margins should follow a pattern where they eventually revert back to a mean historical average, and if they don’t, strange forces are at work in global markets, reports Bloomberg.
“We are always wary of guiding for mean reversion,” reads the Goldman Sachs analysis. “But, if we are wrong and high margins manage to endure for the next few years (particularly when global demand growth is below trend), there are broader questions to be asked about the efficacy of capitalism.”
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