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Bill Gross, co-founder and former chief investment officer at Pacific Investment Management Co., said stocks are “clearly overvalued” and that bond yields would need to fall “significantly” to justify current valuations. 

In an investment outlook published Wednesday, Gross said neither bonds nor equities are attractive, even after the recent selloffs, because inflation leaves little room for the Federal Reserve to lower rates from a 22-year high. 

“I’d pass on stocks and bonds in terms of future total returns,” he wrote, while adding that bonds are a “better deal” than equities in an economic slowdown or recession.

Gross said the “best bets” are arbitrages in mergers and acquisition deals, including Microsoft Corp.’s $69 billion bid for of Activision Blizzard Inc., which he expects to close in about two weeks. Pipeline Master Limited Partnerships are also among his favorites. MLPs trade on exchanges, focus on natural resources like oil and gas and offer higher yields and tax advantages.

Yields on 10-year Treasuries hit a 16-year high this week as the realization that the Fed will likely keep borrowing costs high continued to sink in. The move was mostly driven by inflation-adjusted, or real yields, which have risen to 2.4% from about minus 1% two years ago.

Normally, a surge in real yields of this magnitude would have pushed the S&P 500’s forward price-to-earnings ratio to 12 from 18 currently, Gross said. But he said the excitement about the potential for artificial-intelligence breakthroughs and rampant government spending have blunted the impact.

Even so, “can AI and $2 trillion fiscal deficit going forward validate that ‘it’s different this time?’” he wrote. “I am suspicious.”

Written by: Ye Xie @Bloomberg.com

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