QUARTERLY LETTER

3rd Quarter 2012 — Investment Strategy Review

“Never risk what you have and need, for what you don't have and don't need.”
                                          — Warren E. Buffett


The U.S stock market rallied during the third quarter propelling the S&P 500 index to a 14.6% gain for the year-to-date. This advance, given the precarious macro environment, has stunned many investors who expected stocks to languish. Heading into the summer, everyone was worried about the impact of the European debt crisis, weakening global economy, U.S presidential election, and looming “fiscal cliff”. As we head into autumn, these dangers remain front and center along with new threats in the Middle East and violent social unrest around the globe. Investors would be wise to buckle up for a bumpy ride.

Credit for the stock market's advance has to go to Federal Reserve chairman Ben Bernanke, whose radical monetary strategy is attempting to revive economic growth and job creation by pushing liquidity into riskier asset classes like equities and real estate. The Fed has just launched a third round of quantitative easing. This action has zapped yields on the safest fixed-income securities, forcing investors to seek higher returns elsewhere. To us, the idea of purchasing stocks simply because of zero-percent interest rates is absurd. Over the long-term the stock market is driven by fundamentals such as earnings, not the whims of central bankers. Furthermore, the FOMC's recent policy statement said the following: “strains in the global financial markets continue to pose significant downside risks to the economic outlook”. Bernanke's latest move looks a bit desperate, so do not throw caution to the wind.

Warren Buffett's quotation above is sound advice for all investment seasons, but seems extra prudent today given the abnormal interest rate background. We are concerned that people will invest their mattress money - CDs, T-bills, money market funds, and other short-term cash equivalents currently earning nothing without fully understanding the risk of higher-yielding alternatives. A symptom of the current mood is the following headline from the Financial Times: “Riskiest US Junk Bonds Enjoy Strong Demand in Yield Hunt”. The Fed's zero interest rate policy is distorting the capital allocation process. Longer-term bonds yielding more than cash have become extremely high risk, because rates will not remain low forever. Bond prices will fall once rates rise, which will expose many to unanticipated losses. Investors, both individual and institutional, must be prepared for an era where fixed-income securities play a much smaller role in their asset allocation. As discussed in earlier letters, bonds have been in a 30-year bull market that has rewarded a big portfolio weighting. Be careful, those days are about over.

As value investors we assess the risk of loss over the long haul. We believe that the highest quality equities will provide the most attractive margin of safety during the investment cycle ahead. The fearful climate in recent years has allowed us to accumulate the shares of dominant enterprises at bargain prices and we see no reason to deviate from the strategy. Remember – the better the business, the better the long-term return, especially when purchased at a reasonable valuation. We realize that the macro outlook is uncertain, but it always is. The one thing that can be counted on is that durable businesses will grow well into the future. Legendary investor Ben Graham once observed that in the short run, the stock market is a voting machine – emotionally gauging which companies are popular and unpopular. However, in the long run, the stock market behaves like a weighing machine - accurately appraising the substance of a company. Today, some of the world's greatest corporations are being shunned by the voters, which presents an opportunity for patient value hunters.

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

9/30/12           Henry D. Mercer III

Index Return (Year-to-Date)   12/31/11 9/30/12
S&P 500 +14.6% Fed-funds 0 - .25% 0 - .25%
DJIA +10.0% 10 yr. T-note 1.88% 1.64%
    Oil (W.T.I.) $98.53 $92.19
    Gold $1,565.80 $1,771.10

* 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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