3rd Quarter 2010 — Investment Strategy Review

“There are two times in a man’s life when he should not speculate; when he can’t afford it and when he can.”
                                          — Mark Twain

“Speculation is the mother of all evils.”
                                          — Gordon Gekko

So far in 2010, the U.S. stock market has swung between winning and losing quarters without making much progress. The S&P 500 index rallied 10.7% during the third quarter leaving it with a gain of 2.3% year-to-date. Investors remain confused by the uncertain economic and geo-political outlooks, while financial markets continue to be influenced by short-term news, not long-term fundamentals.

As discussed in recent letters, we are bullish about the future primarily because pessimism is so abundant. History shows that the ideal time to buy is when investors are fearful and we can think of few times when sentiment has been as gloomy. We do not mean to minimize the seriousness of the U.S.’s problems, but investors are forgetting that the country has experienced far worse crises in the past – depressions, World Wars, etc. – and managed to persevere. Last month The New York Times ran a front page article headlined, “In Striking Shift, Investors Flee Stock Market.” The current atmosphere is the exact opposite of the peak of the tech mania in early 2000, which proved to be a disappointing time to invest. Back then, a euphoric public would purchase anything with a stock symbol. Today, incredible values among the highest quality companies are ignored. Pessimistic gurus such as Nouriel Roubini, Nassim Taleb, and Meredith Whitney have become media darlings. This also contrasts with a decade ago when wildly bullish forecasters grabbed the spotlight just as stocks tanked. Remember, the markets do not reward conventional wisdom. 2010’s super bears are likely to be as humiliated as the super bulls were in 2000.

Investors have been redeeming U.S. equity funds and piling into bond funds which seems foolish given the miniscule level of interest rates. This exodus from stocks is fueled by anxiety and a misconception that bonds are risk-free. Some are referring to this pursuit as “return-free risk”. Investors are forgetting that U.S. Treasuries have already experienced a massive bull cycle. The 10 year T-note yield peaked at 15.84% back in 1981 and currently rests at 2.52%. It has been a one-way winning bet for almost thirty years. Historically, interest rate cycles have experienced multi-decade swings, so the long-term decline in bond yields is not abnormal. During the past century, interest rates rose from 1900 to 1920, fell from 1920 to 1946, rose from 1946 to 1981, and have fallen from 1981 to the present. Investors need to be preparing for the likelihood that interest rates will begin a gradual increase lasting many years ahead. This scenario will cause losses for people seeking safety in bond funds.

Lastly, who would ever think that Mark Twain and Gordon Gekko would have something in common? Twain was a terrible investor who lost a bundle during his lifetime and his warning above about speculation still rings true today. It may have even inspired Gekko’s memorable line in the just released “Wall Street: Money Never Sleeps”. Since the original “Wall Street” premiered in 1987, investors have experienced a series of booms and busts. This is the cyclical way of markets and always will be, which is why Mercer Capital keeps the focus on value and margin of safety.

Thank you, as always, for your confidence and support. Please call anytime.

9/30/10           Henry D. Mercer III

Index Return (Y-T-D)   12/31/09 9/30/10
S&P 500 +2.3% Fed-funds0 - .25%0 - .25%
DJIA +3.5% 10 yr. T-note 3.83% 2.52%
  Oil $79.36 $79.97
   Gold $1,095.20 $1,307.80

* 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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