QUARTERLY LETTER

1st Quarter 2012 — Investment Strategy Review

“Right now, bonds should come with a warning label.”
                                          — Warren E. Buffet


The stock market has been experiencing an impressive rally and history says this may bode well for the future. After advancing 11.4% in the fourth quarter of 2011, the S&P 500 index climbed another 12% during the first quarter of 2012. According to Sam Stovall of Standard & Poor's Capital IQ, since 1945 there have been ten instances when the index has displayed comparable back-to-back Q4 and Q1strength and the subsequent full-year gains have averaged 22%. It is hard to imagine, but the S&P 500 now rests only 10% below its October 2007 all-time high. Many investors are stunned by the rebound. Institutional players such as hedge funds have been frozen by the considerable macro risks and remain underweighted in equities. Meanwhile, Fed chairman Bernanke has indicated that the central bank's accommodative monetary policy will stay in force until the employment picture brightens. This is gradually forcing liquidity into the stock market, much to the chagrin of the bears. Conventional wisdom is never rewarded on Wall Street. The last thing expected in 2012 was a surge into record territory by the S&P 500 and now it seems possible.

As discussed in previous letters, we are bullish about the stock market's long-term prospects. Our optimism has been produced by the combination of compelling value and abundant investor pessimism. Typical of the gloomy sentiment background was a special section in a recent edition of The Wall Street Journal headlined, “Why Stocks Are Riskier Than You Think”. This ongoing fear is extremely positive. Successful investing requires a sense of history and the awareness that the most profitable returns are generated from out of favor assets. Unlike the stock market, which has been caught in a vicious bear cycle that began twelve years ago, the U.S. bond market has been the beneficiary of a thirty year bull cycle. Today investors continue to pile into fixed-income securities despite paltry yields, but they should be paying attention to Warren Buffett's warning above. Interest rates must eventually rise and this will cause big principal hits to holders of debt instruments with longer-term maturities. Furthermore, we believe that the investment world is on the verge of what may be a generational asset allocation shift out of bonds and into equities. It will not occur overnight, but could be a major theme in the decade ahead.

Here at Mercer Capital, we have been accumulating positions in the shares of what we call “the best of the best” companies. While no longer dirt cheap, they can still be purchased with an attractive margin of safety and the longer you hold them the better the results are likely to be. Our investment approach is based on one word - “value”. We quote Buffett all the time, but the father of value investing is his mentor, Ben Graham. As a change of pace, we thought a quick spotlight on Graham might be helpful. Besides, Buffett's recent obsession with U.S. tax policy has many wondering if he's been spiking his Cherry Cokes. In short, Graham's key insights are the following:

  • Think of stocks as owning part of a business.
  • Require a “margin of safety”. An investor should only pay a price that is below a security's true worth.
  • Imagine that the stock market is a manic-depressive nicknamed “Mr. Market” whose irrational mood swings can be taken advantage of.
Try to remember Graham when the market turns volatile. We always do.

3/31/12           Henry D. Mercer III

Index 1st Qtr.Return   12/31/11 3/31/12
S&P 500 +12.0% Fed-funds0 - .25%0 - .25%
DJIA +8.1% 10 yr. T-note 1.88% 2.22%
    Oil (W.T.I.) $98.83 $103.02
    Gold $1,565.80 $1,669.30

* 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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