Market

You have to hand it to the International Monetary Fund, they are keen to follow in a rich tradition of banking and investment oversight by seeking to cure yesterday’s ills.  After every crash, bust, crunch, etc., there are cries for something to be done.  The problem, as Alan Greenspan was fond of saying, is that booms, the natural precursor to the bust, are very difficult to spot.  Oh, I know we all think we can see them coming but if that were the case, they would never happen.  The merest hint of a boom would be diffused by us all starting to worry about the inevitable bust to follow.

When very clever people come up with an idea that eventually lands us all in hot water, whether it be the securitisation of debt or portfolio insurance, for example, many with a voice call for its recurrence to be prevented by regulation and legislation.  But this ignores two important truths.

Firstly, booms and busts have been around, probably, since mankind started to barter.  Certainly we have had to live with them since the seventeenth century.  Like the brutality of survival of the fittest and its pivotal role in evolution, this creative destruction usually results in some good, even though there will be losers.

Secondly, it would be a brave banker, indeed, who tries to sell the same type of securitised debt which is causing problems now.  No legislation will be required, you would have to be a bit of a lemon to buy it without reading the small print.  There is little the powers that be can do because they are in an IQ arms race they can never win, the boffins will have moved on to something else which may land us back in the soup in the future but we simply will not know it beforehand.

Lehman Brothers, the US investment bank, have been running their slide rule over the UK economy and coming up with their view for the coming two years.  Amongst a number of predictions, they have come up with an implausibly precise figure of 8% for the size of the drop in house prices.  These organisations are never shy of revising their figures as they are proved wrong but they serve the purpose of gaining column inches and provoke a discussion.

It did get me wondering about the real impact that this would have on most people and, in truth, it would probably be none at all.  I doubt that many people could value their home to within 8% of what someone would be prepared to pay so the real impact on wealth should be minimal.  We will lose something we did not know for certain that we had.

Looking back to the early Nineties, which is the most often quoted property slump, values dropped in nominal terms by 10%, although more in real terms.  Now, if you are sitting in a house worth, say, £300,000 and over the next two years its value drops to £270,000, so what?  It does not impact on the property’s primary purpose which is to keep you warm, dry and secure.  In another ten years, it may be worth £500,000, hardly a blow from which most cannot recover.  So why are we worried? 

In truth, it is because we are not rational creatures, particularly when it comes to investment, and we are least rational about property.  Changes in the value of our home, or flat on the Costa del Sol, affect our mood to a large extent.  If our home rises in value, we feel rich, even though it means that the next property on the ladder has risen by more money, making it harder to buy.

Also, marginal buyers suffer disproportionately.  Those who put down a small deposit may lose it all or worse, may owe more than the property is worth.  People’s mobility is affected.  People spend less when they move less frequently which impacts upon real businesses and jobs.

So, it is a worry but asset values cannot increase continuously without distortions affecting the market.  Periodic shakeouts are a necessity, however unwelcome, to introduce a degree of sanity and remove anomalies.  All property rose in value for no reason than we were rushing to invest in property.  It was, in part, down to speculation as amateur property developers spurred on by TV programmes tried to get rich quick.  Some did and now we will endure a coupleof years of discomfort.  History tells us not to be too pessimistic, though, as those who hold tight will tend to see it come right in the end.

There are a number of things I find strange about the nationalisation of Northern Rock but the most intriguing to me is the Government’s dismissal of market valuations.

The Treasury and its advisers, Goldman Sachs, have flopped about trying to persuade a couple of outfits to bid for Northern Rock. I should have thought that the shear effort required and the number of concessions necessary to bring these people to the table would have given the Government some indication of the scale of the task it faces.  Now having tried to obtain a fair price for the firm, it has turned its back on the market and decided it can do a better job itself.  This seems to show a rather arrogant disdain for the market.  I wonder who will turn out to have got their pricing right?

As a taxpayer, nothing would give me greater pleasure than to see the Government successfully negotiate redundancies, disgruntled shareholders and a marketing revamp to bring Northern Rock back to the market at a tidy profit but there is nothing in their track record to suggest this will go at all well.

It is all very well mixing business and politics when it comes to party funding but history does not throw up many examples of Government involvement in business ownership working well. 

Some politicians have criticised the bidders’ eye for a profit but I do hope the Treasury has one in mind for us.

One of the disappointing things about, mainly, the stock market is that private investors are truly terrible at deriving benefits.  Not so the residential property market.  When it comes to their own homes, people tend not to sell when the market drops; partly because they need a roof over their heads, partly because property is illiquid and most difficult to sell just when you need to do so most quickly, but mainly because homeowners do not want to realise any apparent loss on their home.

The good news for homeowners has been that they spend their 100% of the time invested in the market and, even though they experience slumps in value from time to time, they are always ideally placed to benefit from any upturn.  If you expect the trend to be upwards over the long term, this is a rational way to behave, even if the reasoning is less than analytical.

If we contrast this behaviour with that of the same people in the stock market, it tells a very different story.  Investors seem to head for the market at outset with no particular plan in mind and no thought to timescales or their own expectations.  Perhaps, they have responded to lurid headlines of fantastic returns being made somewhere and worry about missing out.  This may be why so much retail money floods into the fashionable sectors and funds.

If the market drops in value, these same investors sell quickly and move into, for example, cash, worried that losses would become even greater.  Worse still, many simply look at the best performing fund over the last three years, say, and decide to pile into that.

This is why the latest research from Lipper Feri is so depressingly familiar.  Outflows from some very sensible sectors are huge and funds like the Merrill Lynch Blackrock Gold & General Fund have benefited enormously, in its case to the tune of more than £300m.  Now, I am not suggesting that this is the bottom of the market, nor am I saying the Gold & General Fund, which has ridden the good news in commodities, is the wrong place to put money.  All I say is that it is pretty depressing to see all these investors chasing their tails, most simply guaranteeing that they will lose money.

Far better, surely, to have some sort of plan at outset and to use knowledge of the past to manage expectations of the future.  As people have discovered in property, buying into the market and sitting tight forever is not a bad strategy. 

If I had to pick the next investment calamity over the coming couple of years, I might go for Russia.  The reason is that investors seem to have the unerring knack of pulling out of one problematic investment and piling into the next. 

Not long ago, so much money was pouring into Property funds that the regulator had to express misgivings.  Now, a year or so later, those same people are hastily withdrawing their money amidst lurid headlines about the sector imploding.  By the look of things, these people are not giving any more considered thought to their investment objectives than they did the last time, or the time before that.

It does make you wonder what these people or their advisers are thinking.  It does seem that a large proportion of investors have no strategy whatsoever and simply charge around looking for last year’s best performer.  The problem is not that many investments will not deliver, it is that a lot of investors do not stick around to benefit.

The legendary Peter Lynch who ran Fidelity’s flagship Magellan fund very successfully into the Nineties said that his greatest regret was that many of the fund’s investors had just not benefitted from his performance because they had bought and sold at the wrong time rather than just sticking with it.

For anyone whose time horizon runs beyond next Tuesday, it may pay to try to develop a little patience.

For those looking for indications of a forthcoming boom in share values, yesterday’s FT held out some hope.  It reported on research published by the Washington Service who track legitimate insider share trades for 1,900 New York listed companies showing that senior executives and directors bought significantly more shares than they sold. 

According to the FT, the last time company insiders made net share purchases was January 1995 and the S&P 500 grew by 34.1% in that year.  Of course, this is a sample of one so it pays to be cautious but many investors will be hoping for a repeat this year.  That said, the FTSE responded by falling more than 160 points.

For the last ten years, residential property in the UK and much of the rest of the World has been a one way bet; the ones who missed out were those who did not borrow as much as they possible could.  Those who felt uncomfortable with being in debt or who kept betting on a drop in price missed out.  The question for many is whether this is likely to be the story of the next ten years.

If the doomsayers are right and we find ourselves replaying the ‘crash’ of the early nineties, what will this mean to the average home owner?  Officially, prices fell then by about ten per cent, stalled for a couple of years and rocketed off in about 1996.  Of course, the pain of a fall in values will not be evenly distributed.  Those who have to sell will find themselves disadvantaged, although we are much more accustomed to the idea of letting our property now than we were back then.

For anyone who bought, say, a couple of years ago or who does not need or want to sell, will they really notice?  So long as they can afford their mortgage and, with rates looking more likely to fall than rise, affordability is hardly an issue compared with ten years ago, owners can sit tight and let things blow over.  The real losers back in the early nineties were those who sold even though they expected to be homeowners in future.  They found themselves buying into a rising market having lost ground.

Homes also provide shelter, it is not as if we can do without one.  People will not all sell out to hold cash and this provides some underpinning for the market.  As with most assets, it is not market timing but time in the market that delivers the return.  For every ‘clever’ investor who sells out at the top and picks up a bargain, there may be many tales of heartbreak. 

It seems that the woes of New Star, the high profile new boy on the fund management block, worsen by the day.  It seems like only yesterday, or last year, that New Star could do no wrong. Their right ups in the Press were glowing and public and advisers alike rushed into their well performing funds.  Now, its funds languish at the bottom of performance tables, managers are reshuffled between funds and its shares disappoint.

This is neither the time nor the place to analyse the exact reasons for New Star’s travails, which may be short lived, but there are lessons to be learnt from their fall from grace.

Out performance of the market can only come through either manager skill or manager luck.  As with Napoleon’s generals, it seems that it is better to be lucky in the fund manager world.  Manager skill is notoriously difficult to isolate and the marketing machine puts a lot of effort into persuading that positive results stem from skill rather than luck.  This, it seems, plays into the hands of much of the public and their advisers because there is comfort in believing that the person managing your money has a special skill.  In order to outperform the market, a manager must make bets by holding investments in a way which are different to their weighting in the market.  I do not think much of granny’s money would wing its way into a fund were the advertising emphasised that the manager had been very lucky with his bets of late.  No, what the public seek is skill, any sap can be lucky.  Skill is worth paying for, luck is not.

The problem with luck is that it turns.  It also cannot be engineered, it is all down to chance.  So, if stellar performance turns out merely to have been luck, as it usually is, there is nothing for it but to await its return.

None of which brings any comfort to those who bought into the skill story only to find it was down to luck.  Someday, perhaps, investment management groups will have to warn investors that any outperformance can only be attributed to luck.  Another reason to stick to tracker funds.

It seems that the World’s financial markets are entirely dependent on the US and, in particular, the Federal Reserve Bank to provide any stability in times of turmoil.  On Monday stock markets around the world suffered large losses, some more than 5% as worries about the possibility of a recession in the US came to a head.  Panic fed panic amongst investors throughout the day leaving the wider public to digest lurid headlines about financial meltdown.  Monday, as luck would have it, was a public holiday in the US so no trading took place but forward contracts indicated a fall in excess of 5% was likely on Tuesday with the probability that this would trigger further falls elsewhere.

It is possible to argue for creative destruction but market turmoil does no one much good in the long run and can impact on the wider economy, meaning real people can lose their livelihood.  Globalisation may mean that the poorest people in the developing world may suffer the most.  This means positive action to avert the worst of a crisis is to be welcomed and the world was found wanting, consigned to being mere bystanders. 

The Fed, however, sees things differently and cut rates aggressively before markets opened in New York on Tuesday.  This did not prevent stocks falling but it did cushion them somewhat.  London then led the Far East in mounting a recovery of sorts.  It is clear that the current instability has some way to go yet but it may be possible to mitigate against the worst of its effects.

Of course, it is possible to lay much of the blame for these problems at the feet of the Fed but it is reassuring to see that they are not simply standing back and observing events as they unfold.

It looks as if the outlook for the coming year has worsened significantly even since the doom laden reports around the turn of the year.  It is never comfortable for investors watching markets fall whilst sitting in a home which is losing value and there will be some who will wish they had made different decisions.

So what should investors do?  For those already invested, there may be no other rational course of action than taking a long term view and sitting tight.  For those who are not invested, they face the difficult decision of whether to invest or to stay out and risk missing the boat should the market turn.

It is a sad fact of life that retail investors will happily pile into a market when it sits at a record high (viz the residential property market) but get all nervous when the same assets can be had at a discount.  My advice is always the same; if you are investing for the long term, timing your entry into, or exit from, the market is extremely difficult indeed.  It, therefore, makes no sense not to invest.

If this evidence of the bumpy ride which assets provide gives you the wobblies, then you have to question whether you should be investing at all.  You may just have to settle for a much lower prospective rate of growth in return for greater certainty.

Those who have diversified and last a little of the headline growth will, at least, have something for which to be thankful.

Could the Sovereign Wealth Funds of the Middle East and the Far East replace Private Equity as the Bogey Men of the financial markets?

It now seems incredible that people were wringing their hands with worry about the effect that Private Equity firms with their cheaply borrowed money were having on stock markets.  It is almost laughable now that these outfits borrowed a ton of money cheaply, bought a listed company from its shareholders at a premium, gave it a coat of emulsion and sold it back to the original owners (pretty much), pocketing a huge profit in the process.  Only a year or so ago, these people were going to be the ruination of us all, now their antics look pretty tame in comparison with the current woes in the financial world.

No longer can the Private Equity boys borrow money on the cheap, instead, those with cash are king.  No one has more cash than the oil producers of the Middle East and China.  This means that foreign states are buying up chunks of the finest global corporations and other assets on the cheap.  These countries have become more adventurous in their investments as returns on their once favoured US bonds have dropped.  Meanwhile, our institutions are willing sellers.

The industrious Chinese are creating a veritable cash mountain which, individually, they cannot export because of restrictions.  This compels the Chinese Government to shovel cash overseas to stave off all sorts of problems.

Only last year, the US Government opposed for strategic reasons the purchase of a number of ports by Dubai.  This may look like small potatoes in comparison with the level of influence China may end up with on Wall Street.  Ports are hardly portable but the knowledge and experience these banks have is very much more vulnerable.

If you are the type of investor who habitually chases last year’s performance, you will, no doubt, be about to commit a significant proportion of your portfolio to Emerging Markets.  The MSCI Emerging Markets Index was up 35% last year (so long as you measure your wealth in dollars, that is) and has quadrupled investors’ money over the last five years.  With Commercial Property out of favour and Equities in Developed Markets seemingly dogged by uncertainty (is there ever much certainty about the future?), history would suggest that money will be heaped upon those sectors which can show a strong recent showing.  The question for rational investors is whether this makes sense.

There are two ways of trying to answer this, although both are unlikely to be truly accurate.  Firstly, we can fall back on analysis of the fundamentals, e.g., comparison to historic valuations or economic outlook, knowing of course that life is rarely that simple.  Secondly, we can apply the coin flippers technique and wonder whether we can throw heads yet again.  This is not the place to broaden the discussion into statistics but it would be wise to consider how likely the Emerging Markets sector is to do so well over the next five years.

Most of us, however, will simply place our belief in diversification, happy with the comfort it brings and secure in the knowledge that we do not have all our eggs in one basket.  If you have a hunch about the coming year, it might not hurt to punt a very small amount on it, if only for interest.

From here in Perth, capital of Western Australia, where I am visiting, the residential property boom looks somewhat different from the one we have experienced over the last ten years in most of the UK.  In the UK, we have become accustomed to explaining away the furious rise in the prices of homes in terms of supply and demand, i.e., there is insufficient supply to satisfy the demand, which is rising.  There is plenty of land, it is just that we will not let anyone build on the bits of it which are sited where people want to live.  We have surrounded our cities with greenbelt, and very nice it is too, but it does nothing to alleviate the lack of supply.  That lack of supply when coupled with a seemingly limitless supply of easy credit, secured against ever rising prices, has fuelled a tremendous boom.  Now that one of those elements may have been removed as the credit crunch takes hold, it may be that the market will grind to a halt.  The fact that supply is inflexible makes the residential property market inefficient, amplifying the boom and bust cycle.

In WA, some things are similar; the economy is booming creating a surge in demand and mortgages are relatively easy to obtain.  The residential property market in WA, and probably most of Australia, is dominated by new homes.  Not for Aussies the problems and expense of living in a home built for the needs of a different century.  Also, WA is hardly short of land; an area the size of Western Europe accommodates just two million people, mainly around Perth, which is growing at a frightening pace.  Of course, some suburbs trade at a premium as the rich prefer to congregate together but bulldozers carve out new land for building every year.  Want a home?  There is a plot ready and waiting for you to build upon.  This ever increasing urban sprawl brings with it other problems but short of land they are not.  Those hoping for a home in WA may have to wait up to two years for a builder to get around to them, though.

So why have house prices in WA and the rest of Australia been booming much like the UK (and the US, amongst others)?  I put it down to confidence in the economy and easy credit.  It does not really matter what you pay for your home so long as you believe that someone will buy it off you for more (the greater fool syndrome) and the borrowing is cheap and expected to remain so.  No one cares that they are paying twice as much for their home as they would have done ten years ago so long as it doubles in value over the next ten years.  Thus do asset prices lose any connection with the fundamentals.  What’s more, the more they go up, the happier we feel.  Warren Buffett has spoken rather disparagingly of those buyers who wish up the price of investments and it does seem a little irrational to draw comfort from the fact that you will have to pay a great deal more for your next purchase.

Whilst we were in the throes of the boom, here, as in the UK, those who should know better explain things away as being different this time.  If, as seems increasingly likely, this boom derails next year, the same commentators and economists will be telling us how it was all so blindingly obvious that it was going to end in tears.  We wait with bated breath.

There is some evidence (courtesy of the IMF) that the economy in Sub-Saharan Africa is growing faster than the world as a whole.  Not by much but when you consider the considerable effort some of its governments put into preventing any growth, this has to be seen as good news.  It still lags behind the Developing World, taken together, but a case is starting to emerge for including the continent in a portfolio.  I expect that this resurgence is a little fragile; were China, for example, to lose its need for African raw materials, things could take a turn for the worse.

Also, despite the enthusiasm of some fund management companies, it is not an easy place to invest and the local stock markets will not have much capacity for major inflows of capital.  In investment terms, Sub-Saharan Africa tends to mean South Africa plus stocks in companies involved in mining, for instance.  The political risks are considerable in much of the continent and it is probably a long way off being seen as a new China were, for all its faults, the government is seen as stable and not wholly irrational.

Anything Warren Buffett and his investment firm, Berkshire Hathaway, do is bound to attract attention.  Buffett has been a famously successful investor for a number of decades now and investors would be advised to pay attention to his methods which have survived many different fads and economic environments.

I am not putting myself forward as an expert on his techniques, although Buffett makes no bones about sharing these with the rest of us.  His philosophies are seemingly simple; buy when no one else wants to, securing a good price and buy for the long term, Buffett famously said that the ideal holding period for an investment is forever.

We should all probably pay attention then when we read that Berkshire Hathaway has acquired $2.1bn of 'Junk Bond' debt in TXU, a Texan utility.  Of course, when you are sitting on $47bn of cash, that may seem like a reasonable gamble but other buyers have been scarce in this market.  Buffett has probably made a nice little investment and, knowing that he can hold to redemption (i.e., final repayment), will consider the risks to be worth taking.  From a bondholders point of view, utilities make sense because they are unlikely to go out of business and own valuable assets.

As I have said before, we may look back in a couple of years' time and wish we had made more of this credit crunch, such are the bargains that fear creates.

For those holding cash, now could be a fantastic time to pick up some stock market investments at a knock down price, while some commodities (previously, the darling of investors)look overpriced.  Of course, it is perfectly possible that markets could drop further, after all, even if markets are efficient, they are not always rational.  At the moment, however, the stock markets, in particular, are volatile because investors are finding it hard to gauge the full extent of the sub-prime problem and its longer term impact on corporate profitability.

For those looking to hold investments for the long term, the FTSE100 looks a bit of a bargain at around 6300 when it has traded above 6700 only a matter of months ago.  The cautious, though, will be mindful of the fact that the index has yet to regain the heights of 1999 when it exceeded 6900.  It is always possible that we are in the early stages of a protracted bear market but many will find it hard to believe that the banks, even with all their problems, are as bad a profit prospect as their price would suggest.  Now, more than usual, we are seeing the benefits of diversifying.

For some investors, the January Sales have come early in the Stock Markets.

It really is the time for a few well worn clichés, the world's stock markets are having a real roller coaster ride, at the moment.  It is by no means unusual but they seem to be taking their cue from the US and the sentiment over there is all over the place.  No one is quite sure how big a problem the sub-prime crisis is going to be but it starts at huge and goes up to cataclysmic.

The big worry, assuming that the financial system does not implode, is whether the US will slide into recession.  The government, in the form of the Federal Reserve Bank, is pumping vast quantities of cash into the system in the hope that it can prevent it seizing up.  In this, they are being strongly supported by the European Central Bank.

The financial system has shown itself to be remarkably resilient in the past in the face of some very worrying events but, for many investors, this is probably a time to switch off the computer and not look at values for a year or so on the basis that investment portfolios are for life, not just for Christmas.

During the current market volatility, by which, we mean that the stock market valuations are up and down like a yo-yo, nervous investors tend to worry about their prospects for returns.  Also, there is an inclination to obsess about capital growth.

For those with an eye on history and a longer term outlook, however, the real action is in dividend payments.  In this year's Barclays Equity Gilt Study, it shows that £100 invested in 1899 would be worth £213 in real terms on the basis of capital growth.  Reinvest those dividends and the value today would be £25,022, which is quite respectable.

Now, 108 years is longer than most people would expect to be invested but, with longevity increasing by the week, a sixty year old should be planning on the basis that they may be around for another thirty-five years or so.  Even then, they still would not receive one of the many telegrams the Queen sends out every year.

Of course, when markets seem to be dangerous places, it is hard to think long term but, for those who do, there would seem to be every chance of being well rewarded.

In these uncertain times, it is hardly surprising that some investors are turning their attention to Gold, the traditional refuge.  Gold has outperformed most major stock markets this year (up about 20%) as well as many other indices, although Sterling returns are hampered by the fact the Gold, like most commodities, is quoted in US Dollars.

For most investors, though, Gold presents a few practical problems.  Firstly, it is expensive and I doubt many bullion merchants would be happy to sell a small piece of an ingot.  Secondly, it is costly to store and insure; it is hardly much of a refuge for your money if it lying about the house.  Also, most investors would not know where to go to buy it.  On the plus side, allocated bullion represents no credit risk and it does represent a traditional preserver of real value, even if its track record in this is patchy.

Access to gold has recently become easier; a number of ETFs (Exchange Traded Funds) now exist, some of which give access to allocated gold bullion.  This means that investors can include Gold in their portfolios, whether it is a good idea or not is another matter.  

It is all getting a little hairy in the markets at the moment; all major markets posted significant falls yesterday and the news may not be much better today.  Are we witnessing (or, for those of us with investments, experiencing) the final act in the credit crunch tragedy or merely another scene?  Also, what course of action should a rational investor take?

No one can be sure where this crisis is heading; quite a few problems have been brought to the fore but there may be more to come.  It is almost laughable now that, only a matter of weeks ago, our august politicians were focused on the rate of tax paid by Private Equity to the extent that they restructured our entire tax system in an attempt to penalise them.  Meanwhile, in the real world, things were going pear shaped.

Poorly diversified investors may have the least comfortable experience, particularly those poor private investors who held significant chunks of Northern Rock stock for no real reason.  Also, those with too large a proportion of equities may find themselves ruing their lack of investment spread and property looks set for a difficult period.

What is holding up?  Well, the bond markets, unloved of late, may find themselves viewed more favourably (especially government and high quality) and commodities may continue their climb.  But it seems, oddly enough, that emerging markets may emerge (pardon the pun) the real winners from this period of instability.  A year or so from now, they may look quite grown up, while some of the racier classes of investment, such as private equity, may look a little discredited (another pun?).

As ever, the advice to any investor is to ensure that you are properly diversified.  Do not get drawn into this year's must have (or have not) sector and only invest if you have a long term outlook.

The hunt for more scalps over the Northern Rock fiasco rumbles on in Parliament.  The most recent visitors to the dock have been the ratings agencies, who have found themselves widely vilified for their role, real or apparent, in the credit crisis globally and the small matter of a run on a bank here in the UK.

The ratings agencies, of which there are three major players, credit score companies and other institutions who are looking to borrow money in the capital markets.  There has long been a concern over the potential conflict of interest which arises because the borrower pays for their own rating, the concern being that they may shop around to get a higher rating.  Also, the agencies may be reluctant to downgrade the debt in future as it may put off future customers.

So, the ratings agencies have a fine line to walk and it cannot help having governments the world over queuing up to give you a duffing over (the US has already had a go) but it is a lucrative business and, effectively, a closed shop so they don't have to fend off too much competition.  Also, whilst there are concerns, an obvious solution does not seem to be presenting itself so, although we can expect a period of circumspection (probably when least needed), I imagine it will be business as usual pretty soon.

The City and financial markets in general are often accused of short termism and with some justification.  Many of the current problems we are facing in the credit crunch are borne out of a misalignment of the interests of investment bankers and the shareholders in their banks.  As we approach bonus season, the problems are about to manifest themselves in the pockets of bankers who are set to receive less than they had hoped.

Bankers and traders are generally rewarded for their performance in creating profits during the course of the year.  This encourages highly risky strategies which may produce fantastic returns for a few years even if subsequent losses more than wipe out past profits.  The banker will not have to return previous year's bonuses, although they may lose their job.  The shareholder, on the other hand, may see all of their returns over the years reversed within a short space of time.

This is not a case of twenty twenty hindsight, it was eloquently described by Nasim Taleb in his book 'Fooled by Randomness'.  To anyone who had read this book, none of the recent turmoil will have come as a surprise.  The problem is that I think there is no chance whatsoever of a significant change to the way rewards are doled out in investment banks over the long term.  It is just not the nature of the beast.

With the 'resignation' of Chuck Prince of Citigroup this week, the pain being endured in the Investment banking world continues.  These things are relative, however.  No big player is walking into the sunset without a huge pile of cash for their efforts (supposedly, $95m for Chuck), which, I suppose, cushions the blow.

What is intriguing for the rest of us is how these organisations which shower the cream of the academic world with money to labour for them, suddenly wake up to find that they have mis priced something by billions of dollars.  Some of the investments they hold are now worthless.  They have also lent money to companies which bought investments, sometimes from the same bank, which are now worthless, so their loans are looking a little tricky.

By pursuing ever riskier and opaque strategies, they have wiped out years of profits in some departments in a matter of weeks.  It would not be so bad were it not for the fact that these institutions are well placed to spread the pain to the rest of us n the form of more expensive finance or lower returns on our deposits.  Also, they will bounce back more confident than ever and ten years, or so, from now we will see a very similar wiping out of much of the intervening profitability.

To my slight disappointment, the Bank of England Monetary Policy Committee voted to keep interest rates on hold at 5.75%.  I have to confess to having an interest in this as a mortgage holder; it would have made my life a little more comfortable had rates come down by 0.25%.  Despite my interest, I still believe they have got it wrong.  The perils facing us at the moment are unknown and could cause the economy and, therefore, real people, genuine hardship.

The US economy faces the possibility of a recession, at worst, or a serious slowdown.  House prices in the States have dropped in nominal (i.e. cash) terms for the first time since the Great Depression of the Thirties so it is impossible to overstate the seriousness of the current position, although most are relatively sanguine for the moment.  The world is by no means as dependent on the US as it once was but it still represents a large chunk of global activity and China and others have benefited enormously from the outsourcing of manufacturing.  Europe, much of which has squandered all opportunities for structural reform of sluggish economies is being hurt by the fall in the dollar.  If the US slows down by much, this will add to their woes.

It is easy to forget what happened to Japan fifteen years, or so, ago.  An asset price bubble (it is laughable to remember that it was once said that the land on which the Imperial Palace in Tokyo stood was worth as much as California) burst sending the economy into a cycle of low growth and deflation from which is yet to emerge.

No, I worry that the balance of risks lies on the side of a downturn, clearly, though, the MPC disagree.  I hope that they are right.  The old adage is that if America sneezes, we catch a cold.

It has not been a good year for the Bank of England or its governor, Mervyn King.  Firstly, they missed their inflation target and were stung into an ill-judged rate rise and recently they have overseen in part a run on a British bank for the first time sine the 19th century.

The current credit crisis has crept up on them whilst they were looking in the other direction and the fallout threatens to undo all of the good work they have done to their reputation in the ten years since independence.  Inflation (as measured by retail prices) has been slain, or, at least, seriously wounded, but a huge surge in asset prices propelled by easy credit may take years to unwind.

Some asset and commodity price increases are rooted in shortage of supply being outstripped by genuine increases in demand but many (probably some US house prices, for example) are simply a result of access to cheap money enabling people to bid prices up and up.  Get it right, sell your property, downsize and re-enter the world of ordinary RPI much the richer, and you're laughing.  Get it wrong, be born to poor parents too late, and you may never got to enter the market, which, every year pulls further away.

Where is the Bank (or, more accurately, the rate setting Monetary Policy Committee)looking now?  Is it still smarting over earlier mistakes, a collective state of mind which makes further errors more likely, or is it trying to predict where the credit crunch could take us and, therefore, where the greater potential problems may lie?

Having felt the need to react instantaneously on missing their inflation target, it is likely that the MPC will dither over reducing rates. The world has suddenly become a good deal more complicated for central bankers and the next few months will see whether the battered Bank of England can do something to restore its credibility amongst them.

Is the stock market, as a whole, an inherently riskier place to invest money than the residential property market?  Now, I am not for one second suggesting that either is an appropriate place to put your money, although one or both may be, I am just opening up the discussion.  I am also considering the property market in investment terms rather than housing terms, no share portfolio will keep you dry through the winter or give you somewhere to show off your latest plasma TV.  These thoughts are probably, therefore most applicable to excess property investment, by which I mean a second property, a buy-to-let property or a house larger than your requirements, which you hope to sell to fund your retirement.

Firstly, what do we mean by risk?  It is, I suggest, unlikely that the stock market or the property market will drop in value to zero.  It is, of course, possible to make a bad choice of investment.  Some companies will go bust and some properties may become worthless, perhaps because of flooding or encroachment by the sea.  Now, you would be daft to buy a property without insuring it against these risks but most people will buy a share in a company without any corresponding insurance against loss (i may cover how another time).  This, then, starts to colour our view of the relative merits of the investments; we take more risk with our stocks, for some reason, than we do with our real estate.

The world of professional investors usually expresses risk in terms of the volatility of returns.  An investment which can deliver high returns with periodic big drops in values is considered to be riskier than an investment which is more steady in its delivery, even if they end up at the same spot.

So, how does volatility compare?  My main concern here is one of information delivery.  If you valued your share portfolio every year, it may not look particularly volatile and, indeed, in most years it would have gone up in value, probably even in 1987.  This is where the stock portfolio is at something of a disadvantage when compared against property.  You see, property is not valued by anyone, let alone the market (as distinctly opposed to an estate agent or even a surveyor) in anything like real time.  Depending on how often we move, a property may only be market valued, i.e. bought, once every seven years.  We may read in the press about the general sentiment but no one is able to rub our noses in its value in real time, minute by minute.  If you own a stock portfolio, you can watch it go up and down every minute of the working day, responding instantaneously to investor sentiment, and it can be frightening for some.

Also, I have referred to a stock portfolio as opposed to one stock, mostly, as it would not be rational to hold only a couple of different shares.  Diversification is easy with shares, not so with property as it is expensive and slow to sell, amongst other things.  

What of the returns?  Well, ignoring income form dividends or rent, which I gauge to be similar after costs, I think property and equities have probably delivered similar capital growth.  If you take into account transaction costs and the difficulties of diversifying across a number of properties, it may well be that a property portfolio has lost ground to a share portfolio.  What, though, will the next twenty bring?

Investing in commodities, by which, it is normally meant the raw materials for industry such as minerals mined, metals refined or agricultural produce, presents a number of practical obstacles.  Private investors can hardly take delivery of several tons of wheat, for example.  

Traditionally, institutions have made money from the commodities markets by trading in forward contracts, futures and options.  These markets are notoriously difficult territory for smaller investors and not generally appropriate for a long term strategy of buy and hold.

So why the interest in commodities?  Well, they can provide the opportunity of an uncorrelated return to add to an investment portfolio, i.e., they do not go up and down at the same time as equity markets much of the time.  Diversification is central to portfolio construction and the search is always on for assets which increase this.  However, as everyone rushes to diversify, assets can start to become correlated.  That said, there is still a case for the inclusion of commodities, even though they have no income generating prospects, important to many investors.

Most will obtain some interest in the commodity markets by investing in companies which derive their earnings from producing them, mining stocks, etc.  Now, however, there are increasing numbers of Exchange Traded Funds (marketed as Exchange Traded Commodities, ETCs) linked to commodities indices.  These give the opportunity to access returns on a broad range of commodities from platinum to oil to livestock and are worthy of consideration for inclusion in a well diversified portfolio for the long haul.

Why does the Stock Market (and other markets, for that matter) move, sometimes by quite a bit, from one day to the next?  Can it really be that the long term outlook for companies differs significantly between Monday and Tuesday?  To put these movements into context, they are normally not that great; a change in value of 1% is headline stuff as in 'Billions Wiped of UK Stock'.  Hardly confidence building stuff for private investors.

In many ways, investors are much like flocking birds.  If you observe a flock of birds in the evening before roosting, whilst they all move as one, there actual direction seems completely random.  These birds are programmed to follow each other, if one changes direction, the one next to it follows closely and they all change direction.  In nature, this behaviour serves a purpose, these animals stick together for safety and social reasons and it is safer for a bird to follow its neighbour than not, it may have spotted a predator.

Like the flock of birds, the market has no leader showing the way and it seems to move in an entirely random way.  Albeit, we expect a long term upward trend.  The financial press puts a great deal of effort into explaining these market movements afetr the fact but, in truth, investors are just flocking most of the time.  There will, of course, be the odd, random event which greatly changes the long term outlook but, for long term investors, even these should not be seen out of context.