2nd Quarter 2013 — Investment Strategy Review

“Economic theory doesn't work with human beings ”
                                          — Jeremy Grantham

Volatility returned late in the second quarter awakened by comments from Fed chairman Ben Bernanke that the central bank might soon scale back the bond buying related to its quantitative easing. Following a powerful rally in early 2013, the U.S. stock market has corrected as of late, but the overall performance remains solid. The S&P 500 index, for example, finished the first half with a gain of 12.6%. Here at home, the investment climate has been placid compared to the rest of the world. Emerging markets, in particular, have experienced severe declines. Once touted as economic miracles, key developing nations are being pressured on a number of fronts. China is battling a seizure in short-term credit and massive demonstrations have broken out in Brazil. Symptomatic of the current atmosphere is a recent front-page New York Times article headlined “Brazil, Fortune and Fate Turn on a Brash Billionaire.” The piece chronicled the collapse of the business empire of Brazilian, Eike Batista, who had amassed leveraged holdings in oil, mining, shipping, and real estate. Not long ago, Batista was bragging that he would become the world's wealthiest man. His reversal of fortune happened quickly when a slowing Chinese economy halted the global commodity boom. Natural resource rich Brazil had been a prime beneficiary.

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.

Veteran market strategist Jeremy Grantham has been a vocal critic of the Fed and his comment above that “economic theory doesn't work with human beings” is on target. This is something that academics like Bernanke fail to comprehend. Most investors behave emotionally, not rationally, and their behavior is impossible to model. History also shows that markets are going to go where they are going to go. Central bank interventions have often been overwhelmed. One of the most famous examples occurred in 1992 when Quantum Fund's George Soros and Stan Druckenmiller “broke the Bank of England,” making billions in the process. Back then, they helped trigger the devaluation of the pound, crushing a furious effort by the Bank of England to defend the currency. Today, bond prices have fallen while the Fed remains a buyer. Be careful, this weakening trend can continue even if the Fed does not abandon quantitative easing. In previous letters we discussed the high probability that the 30-year secular bull cycle for bonds was ending and that interest rates were likely to begin a gradual increase that will continue for decades. To put it bluntly, long-term fixed-income securities should be avoided. Please also be aware that bond fund managers battling losses and redemptions will be all over financial television saying bonds are attractive. Listening to their advice now is like asking a barber if you need a haircut.

Here at Mercer Capital Advisers, we invest where the best value can be discovered. We like to accumulate the shares of great businesses possessing durable competitive advantages that can withstand the test of time, and continue to hunt for companies run by managements skilled in the art of capital allocation. Our ideal CEO unselfishly builds value for shareholders, not a personal business empire. Lastly, unlike bonds, the U.S. stock market may have entered a secular bull cycle. Patient equity investors will be rewarded.

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

6/30/13           Henry D. Mercer III

Index 1st Qtr. Return   12/31/12 6/30/13
S&P 500 +12.6% Fed-funds 0 - .25% 0 - .25%
    10 yr. T-note 1.76% 2.48%
    Oil (W.T.I.) $91.82 $96.56
    Gold $1,674.80 $1,223.80

* 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.

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