(FORTUNE Magazine) – If you want to hear a rosy forecast for the U.S. stock and bond markets, don't ask Bob Rodriguez. For more than a year, the CEO and director of First Pacific Advisors has been complaining about how he can't find much to buy in either asset class. Instead, he's been stockpiling cash--lots of it. His FPA Capital (FPPTX) equity fund and FPA New Income (FPNIX) bond fund have more than 30% of assets parked in the green stuff. Why? "The investment landscape is a vast wasteland," he says, with hardly a trace of irony in his voice.

Rodriguez, 56, isn't your garden-variety bear. His claim to fame is that he's never posted a calendar-year loss during the 20 years he's been running his bond fund. That's helped him amass more than $2 billion in assets. He's not too shabby as a stock picker either. FPA Capital has a ten-year annualized return of 18%, according to fund-tracker Morningstar. That beats more than 90% of all mutual funds in that span. (FPA Capital is currently closed to new investors.)

Rodriguez's gloomy view starts with his belief that inflation is significantly understated by the consumer price index (CPI). He cites health-care costs as an example. While they're rising at double-digit rates and account for 15% of total economic spending, they make up only 6% of the CPI. Rodriguez says inflation in housing is also understated, because the CPI gauges rental rates rather than home prices. Low interest rates have spurred more Americans to buy homes, driving up home prices. But rental rates have remained relatively flat of late.

The implication for bond investors is clear: Rising prices will prompt the Federal Reserve to jack up interest rates, sending bond prices tumbling. And stock prices are vulnerable too, because higher rates boost corporate borrowing costs, cutting profits.

At FPA New Income, Rodriguez declared a "buyer's strike" on long-term bonds in June 2003, arguing that their low yields aren't sufficiently compensating investors for interest-rate risk. He expects the yield on the ten-year Treasury bond to hit 5.5% to 6% within five years, up from 4.2% now. As a result, he has reduced his fund's duration--a measure of interest-rate sensitivity--to just over a year, a remarkably low level. Rodriguez has 25% of the fund in short-term U.S. government agency securities. And he has stashed another 35% of his portfolio in liquid assets like money markets and short-term Treasury Inflation-Protected Securities (TIPS), which automatically adjust principal (and interest payments) for inflation. "The fixed-income market is trash," he says. "So we're not going to play."

On the equity side Rodriguez is hardly more optimistic. Twenty years of mostly rising share prices have left stocks close to fully valued, in his view. Based on his estimate for a rising Treasury yield--which will make bonds more attractive vs. stocks over time--he expects the price/earnings ratio of the S&P 500 to contract from 18 to 15 over the next five years. Consequently, he believes the average annual return of the market is likely to fall from the usual 8% to around 5% over that span.

Rodriguez's typical equity strategy is to place big bets on small and midsized stocks when they are out of favor and hang on until they reach what he calculates as their fair value. Today, however, fewer than 100 out of 10,000 stocks make it through his customized screening process, which looks at various ratios such as price-to-book value, price to earnings, and other measures. (Typically, the screens turn up 250 to 400 stocks as potential buys.) As a result, he currently has 34% of the portfolio in cash, close to a 20-year high. Rodriguez has been bullish on energy stocks for some time and still sees long-term earnings growth in the sector. But after a run-up in share prices over the past couple of years, he says, the stocks are too expensive to buy at the moment.

Recently, however, Rodriguez has uncovered some bargains in an unlikely place: the tech sector. Among the few stocks he is buying now are Avnet (AVT, $16) and Arrow Electronics (ARW, $22). The two companies are the largest players in the electronic-components distribution industry--they act as the middlemen between the makers of computer chips and the manufacturers of equipment like ATMs, computers, and other electronic devices. An industry downturn has battered both firms, leaving their stocks trading for 11 to 12 times fiscal 2005 earnings and slightly above their book values. But Rodriguez says both companies are cleaning up their balance sheets, and that at the current price the stocks offer investors a low-risk way to invest in technology.

A low-risk way to play high tech

The stocks of these electronics-components distributors are cheap by almost any measure.