Robert Arnott, the founder and chairman of Research Affiliates and the “Father of Fundamental Indexing,” seems to have acquired a reputation as a “perma-bear.” But he might more accurately be described as a contrarian.

“What has happened is that I happened to be a bear when there were very few around,” he says. “I think there are currently a lot of markets that are very attractive. So, I have a bit of an outlier perspective.”

Instead, he describes himself as a bear at times when the markets are expensive and yields are low. In one of the roughest markets in modern history, Arnott sees plenty of attractive areas.

Conversion bonds, at their current levels, strike him as interesting. “Through October, they have fallen more than the stock market, which is weird, because they’re bonds.”

But Arnott notes that in November, although stocks have fallen further than conversion bonds, their drop is still remarkable.

“It represents a marvelous opportunity for those with resources to buy,” Arnott says. Other areas he thinks present opportunities are emerging markets and TIPS.

Many investors and analysts seem intent on calling a bottom, but Arnott feels there’s a better than 50-50 chance of another meltdown in the markets. “Some of the bond markets are priced to reflect a repeat of the Great Depression,” he points out.

If the bonds are, in fact, correct, stocks will indeed have another meltdown. But if the stocks are right, bonds should deliver spectacular returns, and some areas of bonds are more attractively priced than the broader market, he notes.

Last week, the country witnessed the beginnings of some direction from President-elect Barack Obama. Arnott is pleased with what he’s seen so far.

“I think that what has been absent until this past week is any hint that clarity was coming.” Obama realized his comments about having one president at a time was a mistake, and the steps to be more proactive since then seem to be working, for the most part.

Arnott also praised both Obama and President Bush for working hard to create a smooth transition between their administrations while seeking bipartisan ways to deal with the economic recovery, which has left few untouched, including Arnott.

“Let’s just say I didn’t emerge unscathed, but probably fared better than most,” he says.

Arnott has been a bear in the downturn, and as a result, has had short positions on stock index futures, which helped him some. However, he says, “I think it’s fair to say that I’ve been hurt by the fact that the stock market crash had contagion rippling across a wide array of markets that are normally defensive.”

Fundamental indexing was created to remedy a “defect” in market-cap weighted indexes, which select stocks by their market value. Arnott and others believe that returns on those indexes are hurt because they tend to overweight stocks that are trading above their fair value. Arnott believes that the coming years should be kind to fundamental indexes.

“The reason is very simple: they way they add value is not just to its value tilt, but through its contra-trading against the market’s most extreme bet.”

Just two years ago, Arnott points out that the spread between the companies with the highest and lowest price-to-book values was almost the narrowest that has been seen. Today, that spread has widened out to where companies with a low price-to-book have been savaged. This has led to a situation where some of the biggest bargains can be found on the value side of the market.

Among the wide range of indexing types, Arnott predicts that equal weight and deep value should perform very well; cap-weighting and growth will lag.

“I think we’re looking at a situation where if the economy turns quickly, growth could be hit hard. If it does recover, value should recover nicely,” Arnott says.

Tags: Bond ETFs, Emerging Markets, Obama, TIPs