QUARTERLY LETTER

3rd Quarter 2013 — Investment Strategy Review

“We need to stop and admit it: we have a prediction problem. We love to predict things - and we aren't very good at it. ”
                                          — Nate Silver


September marked the fifth anniversary of the bankruptcy of Lehman Brothers and the horrific financial panic that followed. Today, thanks to aggressive action by the Federal Reserve, the U.S. stock market has rallied to new highs, but the economy remains challenged. This disparity has confronted the central bank with a dilemma. Tapering quantitative easing may damage the economy, while maintaining it encourages speculative behavior. Comments earlier in the summer by Fed chairman Ben Bernanke led Wall Street to believe that a reduction in quantitative easing would be announced at last week's FOMC meeting. Investors were surprised, or we should say confused, when it was not. Legendary hedge fund manager Stan Druckenmiller had a more pointed reaction. During a rare appearance on CNBC he said, “To me, they blew it.” Investment veterans like Druckenmiller are fully aware that monetary policy left too loose for too long can create dangerous financial imbalances. 2008 is a classic example. We are not implying that the current environment resembles five years ago, but excesses are emerging. Prices paid for the highest-end New York City co-ops are skyrocketing and the same is true for oceanfront palaces in the Hamptons. NYSE margin debt has surpassed 2007's record. Momentum stocks like Tesla Motors have become easy cocktail party chatter. Big buyers have even returned to the Keeneland yearling sales. In certain circles, it is as if the panic never happened.

The economy populated by the less fortunate has not prospered. This is disappointing given that the Federal Reserve has been providing liquidity at a rate of $1 trillion annually via purchases of U.S. Treasuries and mortgage-backed securities. The scale of this stimulus is unprecedented. Warren Buffett was not kidding when he recently said, “the Fed is the greatest hedge fund in history.” As mentioned earlier, the central bank has a tough decision to make and we have little confidence that it will be the correct one. Both tapering and not tapering will have consequences. In his brilliant new book The Signal and the Noise, Nate Silver attributes the cause of 2008's financial crisis to “a catastrophic failure of prediction” and his comment above is why we are worried. The Fed was unable to foresee the biggest collapse since the Great Depression, yet is now willing to make a multi-trillion dollar wager based on its ability to predict the future. Let's hope that the economic growth envisioned materializes soon.

2013 has been a winner so far. The S&P 500 index has advanced 17.9%; however, the remainder of the year will present the market with a number of hurdles, the first being the grappling in Washington D.C. over the debt ceiling. From an investment standpoint, bargains have become scarce and we would welcome a near-term pullback. Our job is the rational allocation of capital, not prediction. We look to invest in dominant businesses that possess durable competitive advantages at prices below their long-term intrinsic value. Five years ago value was abundant among the types of companies we favor. Right now, we still anticipate these holdings will produce attractive returns, but the price tags are not as cheap as they once were.

Patience is the key to successful investing. It is amazing how wealth can be generated by owning a meaningful stake in a terrific business and just hanging on. Take a look at Wal-Mart for example. Sam Walton took the company public in 1970 and 100 shares could have been purchased for $1,650. Twenty years later those shares were worth $3.2 million. Sam died in 1992, but the Walton family has held on to its shares. According to Forbes, the holdings of Sam's four children are now worth $136 billion. Each of them is ranked among the top 10 wealthiest American's on the magazine's 400 list. Their combined fortune is almost double number one on the list, Bill Gates, at $72 billion. Amazing…The beauty of the stock market is that you do not need to start or manage a company like Wal-Mart to be an owner and think like one. This is the basis for what we do here at Mercer Capital. Invest in high quality enterprises, run by good people, and then allow time to work its magic.

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

9/30/13           Henry D. Mercer III

Index 1st Qtr. Return   12/31/12 9/30/13
S&P 500 +17.9% Fed-funds 0 - .25% 0 - .25%
    10 yr. T-note 1.76% 2.61%
    Oil (W.T.I.) $91.82 $102.33
    Gold $1,674.80 $1,326.50

* 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.

View the Archives