QUARTERLY LETTER

Year End 2017 — Investment Strategy Review

“Fools, as it has long been said, are indeed separated, soon or eventually, from their money. So, alas, are those who, responding to a general mood of optimism, are captured by a sense of their own financial acumen. Thus it has been for centuries; thus in the long future it will also be.”
                                          — John Kenneth Galbraith


The perfect word to sum up the U.S. stock market’s performance in 2017 is astonishing – not only for the sizable advance, but also for the minimal volatility. Twelve months ago, Wall Street forecasters had been stunned by the Trump bump following the presidential election and few were expecting it to maintain upward momentum. Bull cycles thrive on skepticism and 2017 will serve as a classic example. The S&P 500 index closed out the year with a gain of 19.4% with low interest rates, improving earnings, and the prospect of corporate tax reform providing the fuel. Even more astonishing is the persistence of the uptrend and the calm trading action, especially in light of the reality show in the White House and partisan dysfunction on Capitol Hill. Almost twenty-three months have passed since a decline of greater than 5% versus the six-month norm. Furthermore, there were only eight sessions during 2017 in which the S&P 500 rose or fell by 1% or more, way below the historical average – quite odd given the crazy news backdrop.

From a big picture perspective, the current bull cycle is nearing its 9th birthday and only one advance since World War II has survived longer. Logic says to expect a correction or perhaps something worse; however, the rally has still not generated a level of speculative euphoria characteristic of significant trouble ahead. This is also strange. Cabdrivers are obsessed with bitcoin, not stocks. Talk about nuts…

The consensus prediction among investment strategists is a modest gain for the stock market in 2018. History shows that one does not succeed by following conventional wisdom and it would be reasonable to expect an outcome different than current forecasts. Given the fact that the rally has still not produced widespread bullish sentiment, there is the possibility that the market enters a melt-up phase before reaching a psychological peak. Such a scenario would be dangerous for those swept into the frenzy. If the situation gets crazy, remember the wise observation by John Kenneth Galbraith cited above. Galbraith’s most famous book, The Great Crash 1929, is perhaps the best overview of a speculative investment mania ever written. Please do not misinterpret what we are saying. A collapse is not imminent, but a steepening stock market climb next year without a correction would be dangerous.

The most infamous financial bubbles have occurred during eras featuring loose monetary policies and abundant liquidity. Today, a case can be made that the radical response by central banks to the 2008 panic has produced bubbles in a number of asset classes such as bonds, art, luxury real estate properties, and bitcoin. In comparison, stock valuation has become expensive, but not absurd.

Low volatility has made it challenging for us to deploy fresh capital into equities. Our investment mantra is margin of safety. That means we are picky about the prices paid. To put it in simple terms, the better the starting value, the better the long-term rate of return. True investors welcome occasional market weakness, because it provides a window to accumulate shareholdings with a higher probability of success. The absence of a pullback in 2017 has been frustrating, but discipline now will help us avoid disappointment later. In the meantime, we also are remembering the following comment from fabled investor, Charlie Munger – “It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”

Thanks, as always, for your encouragement and support. We hope that you have a happy, healthy, and prosperous 2018.

12/31/17           Henry D. Mercer III

Index 2017 Return   12/31/16 12/31/17
S&P 500 +19.4% Fed-funds .50 - .75% 1.25 - 1.50%
    10 yr. T-note 2.45% 2.41%

* Please contact Mercer Capital Advisers, Inc. if there are any changes in your financial situation or your investment objectives or if you wish to add to or modify any restriction to the management of your account. Our current disclosure statement as set forth on Part II of our form ADV is available for your review upon request.

* Mercer Capital’s management fee is billed quarterly, in advance, based upon the market value of the assets on the last day of the previous quarter.

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