Antti Ilmanen contrasts two forecasting methods. Objective forecasts (e.g., using market yields) predict higher returns from low valuations. Subjective forecasts (from investor surveys) extrapolate recent performance, becoming most bullish precisely when objective measures signal the most caution, creating a dangerous conflict for investors.

Historically, US earnings outgrew the world by 1%. Post-GFC, this widened to 3%. Investors have extrapolated this recent, higher rate as the new normal, pushing the US CAPE ratio to nearly double that of non-US markets. This represents a historically extreme valuation based on a potentially temporary growth advantage.

With the S&P 500's Price-to-Earnings ratio near 28 (almost double the historic average) and the Shiller P/E near 40, the stock market is priced for perfection. These high valuation levels have historically only been seen right before major market corrections, suggesting a very thin safety net for investors.

Current market multiples appear rich compared to history, but this view may be shortsighted. The long-term earnings potential unleashed by AI, combined with a higher-quality market composition, could make today's valuations seem artificially high ahead of a major earnings inflection.

Traditional valuation multiples are increasingly misleading because GAAP rules expense intangible investments (R&D, brand building) rather than capitalizing them. For a company like Microsoft, properly capitalizing these investments can drop its P/E ratio from 35 to 30, revealing a more attractive valuation.

Michael Mauboussin argues the market is inherently long-term oriented. For major Dow Jones stocks, nearly 90% of their equity value is derived from expected cash flows beyond the next five years, debunking the common narrative of market short-sightedness and a focus on quarterly results.

Anchoring valuation on a company's typical price-to-sales ratio helps identify buying opportunities when margins are temporarily depressed. This avoids the pitfalls of methods like the Magic Formula, which can mistakenly favor companies at their cyclical earnings peaks, leading to underperformance.

Despite record market highs, the S&P 500's underlying earnings per share (EPS) have not yet recovered to their peak from early 2022. This "narrative violation" points to a hidden earnings recession for large-cap stocks, a fact that has been masked by market enthusiasm and multiple expansion.

Financial models struggle to project sustained high growth rates (>30% YoY). Analysts naturally revert to the mean, causing them to undervalue companies that defy this and maintain high growth for years, creating an opportunity for investors who spot this persistence.