QUARTERLY LETTER

2nd Quarter 2017 — Investment Strategy Review

“The first rule of fishing is fish where the fish are. ”
                                          — Charles T. Munger


The U.S. stock market continued to advance during the second quarter as the major indices posted a series of record highs. Investors have somehow ignored the wacky political atmosphere and focused on the bullish combination of resilient corporate earnings and low interest rates. The S&P 500 index closed out the first half with a gain of 8.2%. Daily trading action has been eerily calm given the overall background. We are not forecasting a correction, but the post-election Trump bump was fueled by the promise of major tax reform, which appears impossible anytime soon. Furthermore, the Fed has begun to raise rates and price/earnings multiples are expensive, making it difficult to intellectualize a significant rally ahead.

As you know, Mercer Capital emphasizes value. When the shares of superior businesses are cheap, we do not stress about the macro picture. Our primary concern is that the massive liquidity created by the world's central banks has encouraged risky investment practices and bloated valuations across most asset classes. For example, Argentina, a nation that has defaulted seven times in the past 200 years, just issued a bond maturing in 100 years. The $2.75 billion offering was gobbled up by supposedly rational institutional investors. Does anyone ever think about return of capital? We are also troubled by speculative behavior that is a byproduct of the serene stock market rally. A recent phenomenon is the popularity of trading strategies revolving around the CBOE volatility index - otherwise known as the VIX. Let's not get bogged down in the complex details, but suffice it to say that certain aspects of the practice are reminiscent of the portfolio insurance hedging blamed for the depth of the 1987 crash. Please be advised - our intent here is to inform, not alarm.

Charlie Munger's comment above sums up the present investment situation, particularly in the U.S., where there isn't much worth fishing for. We'll keep trolling for value, but new ideas are scarce. Our ideal asset is an equity stake in a dominant, well-managed business that can be held for a long time. Investors could be witnessing an evolutionary turning point for business in general. Technology is disrupting business models and many successful enterprises are facing what may become a less profitable future. Everyone is talking about the extraordinary growth of Amazon and the toll this is taking on traditional retailing, but technological change is impacting a wide variety of industries. It is tough, in fact, to think of a business that can easily raise prices. Some even believe that the power of brands will be less influential in the future. All of this is going to impact how we evaluate not just potential investments, but also current holdings.

Amazon's cash offer to acquire Whole Foods Market has investors wondering what Jeff Bezos is up to this time. The company has travelled a vast distance from a simple online vendor of books. At Berkshire Hathaway's annual meeting Buffett and Munger marveled at Amazon's metamorphosis and Bezos's genius, admitting that it was an unforced error not to invest in the shares. As noted recently by the Wall Street Journal, a $10,000 purchase of AMZN at the time of the initial public offering in 1997 would be worth $4.9 million today. This is a gain of 36% compounded annually, which is 155 times the return of the S&P 500 index. However, it was not an easy ride. The stock has tumbled at least 20% during 16 of the past 20 years and more than 40% in almost half of these selloffs. Investors still have nightmares about Amazon's 95% collapse when the late 1990s dot.com bubble deflated. It would have taken incredible fortitude to hang on. There are several valuable lessons to be learned. First - a winning equity investment requires both complete confidence in the strength of the underlying business and patience bordering on stubbornness. Second - do not worry that you missed it. The stock market's manic-depressive personality provides plenty of opportunities to buy low.

Thanks for your encouragement and support. We hope that you have an enjoyable summer.

6/30/17           Henry D. Mercer III

Index Return   12/31/16 6/30/17
S&P 500 +8.2% Fed-funds .50 - .75% 1.00 - 1.25%
    10 yr. T-note 2.45% 2.30%
    Oil (W.T.I.) $53.72 $46.04

* 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.

View the Archives