Our content this month are as follows:-

• Market News Roundup
• In the news
• Books we have read
• Quotes of the month

There was something of a surge in markets towards the end of December, but most of these gains have been eroded throughout January, mainly due to the uncertainty that still surrounds the position of the large banks. Whilst it is unconscionable that the UK government will allow a large bank to go to the wall what is making them nervous is the extent of the liabilities yet to be revealed. In particular they are concerned about the level of foreign debt, compounded by the weakness of sterling.

One analogy we have heard recently is that when a fire is raging your first priority has to be to put it out; there will undoubtedly be water damage subsequently but you will have time to rectify that. Until the fire (in this case the under capitalisation of the banks) is put out, the banks will not feel able to make capital available to businesses and the economy is unable to get going. Once the government grasps this nettle we will be on our way out of the current crisis. In the meantime the headlong drive to reduce interest rates is having little effect simply because, although money is cheap, the banks are reluctant to lend. The government may well regret having used up this tool far too early.

The volatility of the markets has led us to reflect upon the nature of risk and the benefit of volatility. An article in the Economist on January 17 pointed out that low volatility was a large part of the appeal of Bernard Madoff's hedge fund (see more below). In fact this is a much trumpeted "advantage" of many hedge funds and absolute return funds; the

question posed in the Economist article is, "Where is that low volatility coming from?" Could it be the presence of illiquid assets which are rarely bought and sold and therefore rarely valued? If so what is the real value of these assets? With many hedge funds and absolute return funds you do not really know what you have got until you sell it. The most telling remark in the article is: "The more sophisticated the fund manager appears to be, and the more complex the model, the harder it is for the client to tell whether the strategy will produce skewed returns."

Volatility is the investor's friend; investors get paid for the risk they are running and economies rarely grow smoothly, with the business cycle being a fact of life. In the present situation investors have accepted the risk and volatility of the past 18 months. The only thing that makes sense now is to stay involved for the return. It will be of some comfort to you to remember that the current volatility has led to a situation where future expected returns are now much higher than previously.

Barak Obama
The major news story of the month is undoubtedly Barak Obama's inauguration. He has been hailed as a beacon of hope in these difficult times and certainly faces immense challenges. He appears well equipped to lead and strong leadership will certainly be required over the next few years if the world's biggest economy is to return to its accustomed prosperity. I am sure we all wish him luck.

Bernard Madoff
The major financial story continues to be Madoff. A classic Ponzi scheme from a plausible crook. Not only did he take in the rich and famous, he also appears to have fooled HSBC, Royal Bank of Scotland, UBS and many other banks which I suppose is no real surprise given the level of judgement that banks have displayed when faced with easy profits and high commissions.

Ponzi schemes are named after Charles Ponzi who arrived in the United States in 1903 virtually penniless and who built up a fortune of $1.5 million by promising handsome returns to his investors. The classic feature of such a scheme is that new investors pay out returns and redemptions to existing investors until the music stops as it now has with Bernard Madoff. Mr Madoff’s scheme may be the biggest Ponzi scheme ever, with losses initially estimated at $50 billion. His aura of respectability apparently protected him even from complaints to the regulator from other prominent money managers.

There are two major lessons to be learned from this episode. The first and most obvious is that if something seems too good to be true it probably is. The second is that many investors got involved in this scheme because they did not appreciate that there are no magical or secret ways to consistently beat the market.

Private Banks Mea Culpa
A very interesting thing happened at the FT private banking summit in Geneva in December -- Juerg Zeltner, a board member of UBS and head of wealth management for north, east and central Europe said of structured products: "if we are very honest as an industry... Yes, I think we have done mis-selling. I think we have over promised and under delivered and, if we are quite honest, we have done that also because sometimes it was very attractive to us."

We are pleased that the private banking industry has finally admitted that the sale of structured products suits them and not the clients. From what we hear, however, it is obvious that they continue to sell them by the bucket load.

We have to admit to having read this month's selection a little while ago, but have hesitated to recommend it because of its title. The book is by Steven E. Landsburg, the author of "The Armchair Economist" and one of our favourite writers on economics. He has written a new, illuminating and very entertaining book entitled "More Sex Is Safer Sex" and before you ask, yes, it is also on economics.

The book is every bit as good as the title suggests and as well as advocating incentives for the sexually conservative to have more sex, Landsburg comes up with ideas to shorten queues, improve the administration of justice and encourage us to have more children so that they can solve the world's problems. Outlandish as it all sounds you will find yourself admiring the clarity of his thinking and the inventiveness of his ideas.

It is available from good bookstores and Amazon, but if you have any difficulty finding it please contact vickie@indexwm.co.uk.

"It is better to light a single candle than to curse the darkness."
Quaker Proverb

"Criticism is something we can avoid easily by saying nothing, doing nothing and being nothing."
Aristotle