AQR’s Antti Ilmanen – US Exceptionalism: Growth Story or Valuation Trap? | #607

What It Covers

Antti Ilmanen from AQR examines US market valuations at 40x CAPE ratio, contrasts objective yield-based forecasts with subjective rear-view-mirror expectations, and explains why current US equity premiums appear unsustainably thin for the decade ahead.

Key Questions Answered

• •Valuation vs Growth Attribution: Post-GFC US equity outperformance came primarily from valuation expansion (CAPE rising from average to 40x) rather than earnings growth, with richening contributing more than the actual 1% historical US earnings growth advantage over international markets. This pattern typically reverses over subsequent decades.
• •US Relative Valuation Extreme: US CAPE ratio now trades at 1.8x non-US developed markets, near the December 2021 peak of 2.0x. Historical data shows this ratio has 85% predictive power (r-squared) for ten-year forward returns when measured from 1985 onward, suggesting significant mean reversion risk ahead.
• •Objective vs Subjective Expectations: Yield-based objective measures show 0.5 positive correlation with future returns, while rear-view-mirror subjective expectations (analyst forecasts, retail sentiment) show negative 0.3 correlation. Institutions follow objective models on paper but often deviate in practice, staying overweight US despite low expected returns.
• •Bond vs Equity Investor Psychology: Bond investors demonstrate contrarian mean-reversion behavior because they quote forward-looking yields, while equity investors extrapolate past performance because they focus on backward-looking prices and returns. This fundamental difference in framing drives opposite forecasting patterns across asset classes.
• •Diversifier Implementation Strategy: Portable alpha and return-stacking approaches that combine equity beta exposure through derivatives with diversifying strategies (trend-following, multi-factor) prove more durable than standalone diversifiers. This structure prevents investors from abandoning diversifiers during extended equity bull markets when line-item comparison looks unfavorable.