QUARTERLY LETTER

1st Quarter 2013 — Investment Strategy Review

“As investors, we also have to be aware of our innate and very human tendency to be fighting the last war. We forget that Mr. Market is an ingenious sadist, and he delights in torturing us in different ways. ”
                                          — Barton Biggs


The U.S. stock market rally picked up momentum in the first quarter propelling key indices such as the Dow Jones Industrial Average and S&P 500 to record highs. Credit for this historic advance must go to Federal Reserve chairman Ben Bernanke's aggressive monetary policy that has attempted to revive the post-panic economy by enticing liquidity into equities. The Fed does not expect to end “quantitative easing” soon, which has added fuel to the early year surge. Everyone on Wall Street is wondering what will happen to the markets when the central bank eventually dismantles its support system. Cynics say that Bernanke's exit strategy is his retirement. Let's just say that investors are dependent now more than ever on effective decision making at the Fed. Stock prices may have been resurrected, but the economy remains trapped in slow growth. We do not envy Bernanke's predicament.

Forecasting, especially over the short-term, is not our game, but a pause in the rally seems possible. This reasoning has more to do with psychological factors than fundamental. The stock market does not reward conventional wisdom and in recent days a number of strategists have joined the bullish camp. This is negative from a contrary perspective. Last week an article in The Wall Street Journal headlined “Stock Bulls Get a New Member of the Club” noted that a prominent bear who had predicted the S&P 500 would decline in 2013 was now forecasting additional gains by year-end. The piece also mentioned that two other gurus had boosted their upside targets. Excessive enthusiasm can kill rallies, so we are not thrilled by the swing in sentiment. A correction would temper bullishness and enhance the stock market's prospects for the remainder of 2013.

Last summer Wall Street lost one of its most memorable characters, the legendary investment strategist Barton Biggs, who died suddenly at the age of 79. The observation highlighted above is classic. Only Biggs would describe the stock market as an “ingenious sadist.” Biggs wrote a weekly commentary for Morgan Stanley that was a must-read as much for its brilliant prose as the insightful analysis. Investors today should be mindful of his comment about “our innate and very human tendency to be fighting the last war.” The memory of 2008's crash still lingers, but that's the last war. A symptom of this rearview mentality is the investment world's obsession with macro risks such as Washington D.C.'s gridlock, the European debt mess, the health of China's economy, and unrest in North Africa and the Middle East. While, thanks to the Fed, most strategists have a positive near-term outlook, very few are expecting the stock market to thrive in the decade ahead. Again, they are still fighting the last war. The future is unpredictable, or as Biggs liked to say, “nobody knows nuthin.” Nevertheless, we are going to present the bullish case. Since 1857, the U.S. stock market has alternated between lengthy secular bull and bear cycles. There have been five bull phases and five bear, each lasting 14 years on average. To put it in simple terms, the current secular bear market began almost 14 years ago and the climb by the indices to all-time highs could mean that the down cycle is over. History indicates stocks are entering the early stage of a secular advance that will produce sizeable annualized returns. Sure, there will be declines along the way, but the major trend will be up for years to come.

Mercer Capital continues to believe that the highest quality equities will provide an attractive margin of safety and generate superior performance during the investment era ahead. To us this means stable businesses with durable competitive advantages that can be purchased at reasonable valuations and then patiently held. We are also searching for companies run by CEOs skilled in the art of capital allocation - managers focused on cash flow and building value for shareholders. Where's the next Warren Buffett?

Thanks as always for your encouragement and support. Please call anytime.

3/31/13           Henry D. Mercer III

Index 1st Qtr. Return   12/31/12 3/31/13
S&P 500 +10.0% Fed-funds 0 - .25% 0 - .25%
DJIA +11.3% 10 yr. T-note 1.76% 1.85%
    Oil (W.T.I.) $91.82 $97.23
    Gold $1,674.80 $1,594.80

* 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