QUARTERLY LETTER

3rd Quarter 2011 — Investment Strategy Review

“The market has this disturbing habit of ignoring the obvious and ignoring it some more, until, in a blink of an eye, it doesn’t.”
                                          — Jeremy Grantham


The U.S. stock market experienced a miserable third quarter as the S&P 500 declined 14.3%, leaving the index with a loss of 10 % for the year. As bad as it has been here, many international exchanges have fallen much more. This global selloff spread into most asset classes, and commodities such as copper have been notably weak. Even gold, a star performer, has stumbled. Once again, Treasuries have benefitted from a flight-to-safety, pushing yields down to absurdly low levels. The observation above by respected investment strategist Jeremy Grantham provides an apt description for the market’s behavior in 2011. Stocks advanced during the first half ignoring obvious macro risks and then suddenly collapsed in August. Everyone knows the problems, but here is a quick summary of the key issues:

  • A growing awareness that the U.S. budget deficit must be dealt with. It is not a crisis today, but a long-term solution needs to be implemented soon.
  • Political brinksmanship in Washington D.C. is killing confidence, and in turn, the economic recovery. The Fed cannot do all the heavy lifting. Markets are pricing in a double-dip.
  • History shows that deleveraging cycles, unlike typical recessions, can take a decade to play out.
  • The European Union has been unable to deal decisively with the excessive debt of its peripheral nations. How might this mess impact the health of banks holding the paper and also financial institutions originating credit default swaps?
  • Mounting evidence that the economic miracle in China is experiencing a reality check.
  • The proliferation of high-frequency electronic stock trading is creating head-spinning volatility.

Investors need to recognize that these concerns reflect what is going on right now, but say little about what will happen in the future. Our long-term outlook is, in fact, bullish. This optimism is due to several factors, one being depressed sentiment. A constant throughout investment history is the abundance of fear at ideal buying points and it can now be seen everywhere. For example, pension funds, notorious for lousy timing, have been “de-risking” — fleeing stocks and piling into the perceived safety of bonds and other low-volatility alternatives. In addition, individual investors have been hitting stock mutual funds with redemptions. Investor psychology can be tough to quantify, so it is necessary to look beyond the markets and into mainstream culture. The current mood is truly gloomy. You can observe it on the evening news, and hear it at cocktail parties. Just take a look at recent newspaper headlines. Here are some of our favorites: “Investors Lose Faith In Stocks”, “Fear Hits Fall Street”, “PANIC!”, “CRAPS!”, “Tanks A Lot — O’s Rally Cry Ends In Dow’s Massacre”. All this is positive from a contrary point of view.

The central factor contributing to our bullishness is the compelling value being presented by equities. Shares of many high quality companies pay dividends well in excess of the meager yields generated by U.S. Treasury notes, a rare phenomenon. Unlike fixed bond interest, these stock dividends are increased on a regular basis. Today’s leading corporations have stronger balance sheets than governments and are much better managed. Furthermore, the depressed market environment is allowing us to accumulate stockholdings in the most dominant businesses at bargain prices. Warren Buffett once commented, “We have usually made our best purchases when apprehensions about some macro event were at a peak.” This has also been true at Mercer Capital and we are confident it will remain so.

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

9/30/11           Henry D. Mercer III

Index Return (Y-T-D)   12/31/10 9/30/11
S&P 500 -10.0% Fed-funds0 - .25%0 - .25%
    10 yr. T-note 3.30% 1.93%
    Oil (W.T.I.) $91.38 $79.20
    Copper $4.45 $3.15

* 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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