QUARTERLY LETTER

2nd Quarter 2014 — Investment Strategy Review

“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell. ”
                                          — Sir John Templeton


The U.S. stock market continued its winning streak during the first half of 2014 as the S&P 500 index rallied 6.1%. While this year's advance has lacked the upside momentum of 2013, the bull cycle's stamina is impressive. The S&P 500 has not suffered a 10% correction since August 2011. Historically, these setbacks have occurred once every twelve months on average, so investors are experiencing something special. Recent trading activity has also been remarkably calm, which is odd given the volatile geopolitical climate and sputtering economy. The S&P 500 has gone 51consecutive sessions without closing up or down more than 1%, another rare phenomenon. Investors are overdue for a test and perhaps it will happen soon. Mid-term election years often spark corrections during the summertime and value buyers like us would welcome it.

As discussed in previous letters, the current bull cycle is unprecedented in one key aspect - the Federal Reserve has sought to assure the rally's survival. A stated objective of quantitative easing has been to bolster asset prices and it has certainly worked. Our main worry is that the enormous liquidity being generated by the central bank is creating dangerous speculative excesses, especially in the bond market. U.S. retail investors have poured more than $11 trillion into bond funds since early 2009. With short-term interest rates anchored at miniscule levels, investors are scrambling for yield in any form…European sovereign debt, frontier nation I.O.Us, junk credits, leveraged loans - you name it - people are scrambling to buy. The Fed believes it can control the outcome; history says it cannot. This will not end well.

In the meantime, equities continue to look attractive in comparison to other asset classes. Bull cycles undergo a psychological evolution and the observation above by legendary value investor Sir John Templeton describes it well. The current uptrend has entered the optimistic phase, but remains far away from the euphoric. In fact, it is the lingering memory of the panic of 2008 that is restraining enthusiasm for stocks and causing the stampede into supposedly “safer” bonds. Unfortunately, equity valuation today is merely okay and new ideas are scarce. This is why we would welcome a correction. Longer-term, we remain confident that our core holdings, many of them purchased at the time of “maximum pessimism,” will continue to provide attractive returns. However, from current levels performance will by generated more by the quality of the businesses than the cheapness of the shares.

Templeton recognized early in his career how critical it is to take advantage of the stock market's mood swings. Investing is an extremely competitive game and the most skillful investors tend to play only when the odds are stacked in their favor. The best chance of winning comes when markets are under stress and decisions are ruled by emotion, not reason. Fear creates value and few investors understood this better than Templeton. Most of the time markets and investors behave rationally, which can make it tough for disciplined buyers to come up with outperforming ideas. Today thanks to modern technology it is even more challenging. Securities analysis has become a crowded profession and everyone has access to tools that run quantitative valuation screens creating a more level playing field. This condition will not change until fear returns and emotion governs the thought process.

As you already know, here at Mercer Capital we like to make long-term investments in dominant companies. The determination of what makes one enterprise superior to another will always be more art than science, because they often screen similarly. Character of management and competitive advantage, the true separators, are tough to measure. We focus on growing businesses that will become more valuable over time and try to buy at discount prices. Stretching out our time horizon enhances the probability of success. We are also on a quest to discover companies run by talented, unconventional capital allocators who have a long tenure ahead of them. The stock market will not remain calm forever and like Sir John we'll be ready to pounce.

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

6/30/14           Henry D. Mercer III

Index Return (Year-to-Date)   12/31/13 6/30/14
S&P 500 +6.1% Fed-funds 0 - .25% 0 - .25%
DJIA +1.5% 10 yr. T-note 3.03% 2.51%
    Oil (W.T.I.) $98.42 $105.37
    Copper $3.40 $3.06

* 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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