QUARTERLY LETTER

2nd Quarter 2011 — Investment Strategy Review

“Investor psychology can cause a security to be priced just about anywhere in the short run, regardless of its fundamentals.”
                                          — Howard Marks


It is remarkable how similar the investment background is to last summer. Just take a look at the following headlines from The Wall Street Journal which ran almost exactly a year apart.

  • “Fed Grows More Wary on Economy” – (6/24/10)
  • “Fed Lowers U.S. Outlook” – (6/23/11)

In addition to the sluggish U.S. economy which remains bogged down by weak housing and high unemployment, Europe continues to wrestle with Greece, and China wages its fight versus inflation. After a strong start in 2011, stocks began to decline in late April, but then rallied sharply during the past week, leaving most indices little changed for the second quarter. The S&P 500, for example, fell 0.4% over the past three months and finished the first half with a gain of 5.0%. Round two of the Federal Reserve’s quantitative easing ended today and institutional investors became more cautious as this date approached. QE2 was designed to stimulate asset prices and the stock market was a major beneficiary. Prominent hedge fund managers were hoping that downbeat economic data might prompt QE3, but the Fed is standing pat for now. Therefore, it would not be surprising if stocks languish during the rest of the summer.

The scariest risk confronting investors revolves around the credit markets. We hate to say it, but some of the key factors that produced the panic of 2008 still exist. Plain and simple, the global financial system remains clogged with debt and exposed to trouble – everything from sovereign obligations to credit default swaps. While Greece is getting all the attention, many nations are overleveraged. U.S. Treasuries tend to rally when fixed-income investors are frightened, a phenomenon called “flight to safety”. This has been happening lately. Nervous buying pushed the 10 year T-note yield down to a recent low of a mere 2.87%. Short-term T-bills have even traded at negative yields on several occasions, meaning that investors are willing to lose a little money to assure that most of it is safe. Unfortunately, this behavior is reminiscent of 2008. Please do not misinterpret these comments. The risk rests within the credit marketplace. We believe that the current bull cycle for stocks will meander higher at least through the Presidential election in 2012. Nevertheless, 2008’s collapse is a reminder of how interconnected the credit world has become. Central banks, investment banks, commercial banks, insurance companies, financial service companies, hedge funds, money market funds – they all are all linked, and investors have to pay close attention.

Here at Mercer Capital, we focus on long-term investment value and ignore market forecasts. Today, equities represent a compelling bargain versus bonds and cash equivalents. As noted above by Howard Marks, a successful value disciple, markets are often driven by emotion, not fundamentals. Our objective is to recognize when investor psychology has caused assets to be mispriced. The panic of 2008 allowed us to accumulate the shares of dominant business franchises at sensational values. If something goes haywire in the future, try to remember the words of legendary investor, Sir John Templeton, who once said: “To buy when others are desperately selling takes the greatest courage, but provides the greatest profit.” This is how he amassed his fortune, so we view market declines as opportunities and not events to be feared.

Thank you for your confidence and encouragement. Please call anytime.

6/30/11           Henry D. Mercer III

Index 1st Qtr. Return (Y-T-D)   12/31/10 3/31/11
S&P 500 +5.0% Fed-funds0 - .25%0 - .25%
    10 yr. T-note 3.30% 3.16%
   Oil (W.T.I.) $91.38 $95.42

* 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