Bond Guru Bill Gross’ Secret To Investing In An Overvalued Market

The chorus of investing gurus sounding the alarm on bubbles in both the bond and stock market grows almost daily.

It started as early as last year with Vanguard founder Jack Bogle warning that stocks could return as little as 6% annually over the next decade based on record low interest rates and overvaluation.

#-ad_banner-#​DoubleLine Capital Chief Executive Jeffrey Gundlach said last month that investors have entered, “a world of uber complacency,” recommending that investors sell everything and that the stock market should be, “down massively.”

The $100 billion L.A.-based asset manager also went “maximum negative” on U.S. Treasuries, marking a familiar alarm among smart money that investors may find no safety in bonds either.

Bond guru Bill Gross has previously been critical of the massive monetary programs by central banks globally and told Bloomberg this month that it’s, “devolved into Ponzi finance,” and have become, “promises that can never be kept.”

Looking at valuations, the Janus Capital Manager said he doesn’t like bonds or most stocks, but admitted that investors need to put their money to work. 

In fact, against the potential for the financial system to “implode”, Gross said the Janus Unconstrained Fund is holding just 5% in cash.

So what does one of the market’s most savvy managers invest in when almost the entire market is overvalued?

Taking Valuation Out Of Stocks With Deal Arbitrage
An arbitrage trade is generally done by buying an asset in one market and simultaneously selling it in another market, taking advantage of price differences and taking no risk on the trade. It’s most common in currency and commodities trading.

But there’s another form of arbitrage that involves stocks, and it’s one of the few strategies where investors may still be able to book some profits. 

Besides investment in real assets, Gross pointed out merger arbitrage as one of his preferred strategies right now. The trade benefits from the difference between announced mergers and acquisitions offers and current prices of the target company. 

Because of regulatory hurdles and shareholder holdouts, shares of target company stocks do not always trade closely to proposed offer prices. Investors can jump in for a quick long position and earn the difference if the deal is closed.

Even if the pricing difference only amounts to a gain of a few percentage points, the annualized return could reach double digits if the deal closes quickly enough.

Four Deal Arbitrage Positions For Returns In A Crowded Market
Gross specifically called out LinkedIn Corporation (NYSE: LNKD) which is being bought by Microsoft for $196 per share, a premium of about 2% on the current price. The relative narrowness of the price spread reflects the market’s certainty that the deal will close without any problems. There are no regulatory issues and shareholders on both sides of the table have accepted the terms. The deal is expected to close by the end of the year which would mean an annualized 5% return. 

Trina Solar (NYSE: TSL) has agreed to the buyout offer proposed by the CEO and an investor group for $11.60 per share, a 10.2% premium on the current price. Strong stock prices in China drove many companies to propose buyouts last year in the hope to later issue shares at higher prices on the domestic market. While a sluggish market has taken some enthusiasm out of the trade, the Trina Solar deal looks to still be progressing. 

The offer was for a 22% premium from the closing price before the announcement and just above the 52-week high for the stock. The deal is expected to close sometime in the first quarter 2017 and would amount to roughly a 21% annualized gain.

Cvent Inc (NYSE: CVT) agreed to be bought by Vista Equity Partners in April for $36 per share in a deal that is scheduled to close in October. The Department of Justice (DOJ) sent the companies a second request for more information in July, signifying additional scrutiny on the deal. This isn’t uncommon, and even if the DOJ finds reasons to hold up the deal, the companies can agree to sell some assets to get approval. 

The offer price was a 69% premium to the pre-announcement price and a more than two-year high for the shares. Revenue is expected 24% higher this year and could help to find other buyers if regulators raise more questions about the Vista offer. The deal is extendable through April 2017 and represents a 11.8% premium on the current price.

Lexmark International (NYSE: LXK) agreed to be acquired by an investment consortium led by Apex Technology in April for $40.50 per share, a 15.4% premium on the current price. Weakness in printing and computer hardware is driving consolidation in the space, and regulators are unlikely to oppose the deal. The board of Lexmark hired Goldman Sachs to help it find a buyer last October, and the deal is expected to close by the end of the year.

Risks To Consider: Deals can be canceled for several reasons including regulatory problems or disagreements between companies. A larger spread may imply less certainty the deal will close.

Action To Take: Go long in one of the few opportunities in an overvalued market by buying into shares of deal arbitrage companies.

Editor’s Note: If pulling down a yield of 10% a year sounds good — before capital gains — you need to see this. You’ll find stocks paying 15.1%… high-yielding REITs, trusts, partnerships and ETFs. (These cash cows are also posting capital gains as high as +368% for us. I explain that part here.)