3rd Quarter 2015 — Investment Strategy Review

“We are big fans of fear, and in investing it is clearly better to be scared than sorry. ”
                                          — Seth Klarman

The investment environment turned hostile during the third quarter and the U.S. stock market is experiencing its first correction since the summer of 2011. As discussed in previous letters, the absence of volatility was abnormal. 2015 began with an eerie calm and until the late August rout, the S&P 500 index had gone the entire year without advancing or declining 3.5% from its opening level. Again, this is not typical behavior. According to a recently published analysis of historical trading patterns, there has been nothing like it in the past four decades. Investors were way overdue for a test and it is happening now. At its low, the S&P 500 had plunged 12.3% from its high and the index finished the quarter with a 6.7% loss for the year. The rapid selloff brings to mind the classic Wall Street saying that the stock market takes the escalator up and the elevator down.

Turbulence here in the U.S. can be traced to significant events overseas. Following a huge rally that spawned dangerous speculative excesses, China's Shanghai and Shenzhen stock exchanges have crashed, and clumsy attempts by Chinese officials to stabilize the situation have been a dismal failure. Many are concerned that this collapse is signaling a major contraction by the Chinese economy. The tension has also been exacerbated by a surprise devaluation of the yuan. This, in turn, triggered wild swings among currencies, pressured already weak commodity prices, and forced stunned hedge fund managers to pull capital out of once popular emerging markets such as Brazil. A feature of modern finance is how intertwined everything has become. We do not want to get bogged down in the details, but the happenings in China and the developing world do matter.

Poor communication by the Federal Reserve is not helping. Without question, the U.S. bull cycle has been fueled by the ultra-accommodative monetary policy of the central bank. Today everyone is obsessed with what might unfold there. FOMC meetings and the public comments of the Fed governors get as much coverage as the Kardashians. Unfortunately, the transparency has increased the confusion. After hinting that an interest rate hike was probable before year-end, no action was taken at September's FOMC meeting and the policy statement seemed to rule out a near-term increase. Last week Fed Chair Janet Yellen gave a speech that indicates she still expects a hike in 2015. Investors are going to be hesitant until there is more clarity. The Fed is trapped in a Catch 22-like quandary. Asset prices have inflated, but not consumer prices. Moving interest rates off the zero bound will have consequences. Wish we had more confidence that the Fed will choose wisely.

Our cynicism does not mean that we are bearish about the future. As long-term value investors, we welcome volatility. A positive development is the return of pessimism and nerves will be on edge during the notorious month of October. As noted above by renowned investor Seth Klarman, the best buying opportunities occur when you are scared. Market corrections are healthy, because they keep sentiment in check. Euphoria kills rallies, while skepticism sustains them. It is axiomatic when it comes to investing that conventional wisdom tends to be wrong. A growing number of strategists and portfolio managers are forecasting gloom and doom, which is bullish from a contrary perspective. Newspaper front pages have also been loaded with panicky headlines. Here is a quick sampling: “Turmoil Greets Central Bankers”, “Stocks Deepen Their Slide After a Rebound Collapses”, “WILD! Bears Maul Marts in Dizzy Dow Spiral”, “Global Stocks Sell-off As China's 'Black Monday' Darkens Markets.” Historically, negative page one articles have been a characteristic of stock market bottoms, not tops.

The current decline is enhancing the long-term margin of safety for equities. Throughout most of 2015 our biggest dilemma has been the absence of compelling value, but fear is now producing bargains and we are ready to buy if the stock market's clearance sale continues in October. As you know, Mercer Capital's game plan is to concentrate our attention on dominant businesses that will become more valuable over time and then invest at discount prices. The scary macro atmosphere is giving us a chance.

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

9/30/15           Henry D. Mercer III

Index Return   12/31/14 9/30/15
S&P 500 -6.7% Fed-funds 0 - .25% 0 - .25%
DJIA -8.6% 10 yr. T-note 2.17% 2.06%
    Oil (W.T.I.) $53.27 $45.09

* 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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