QUARTERLY LETTER

3rd Quarter 2016 — Investment Strategy Review

“If you can't forecast well, forecast often. ”
                                          — John Maynard Keynes


Investors seem to care about only two things these days - the future course of the Federal Reserve's monetary policy and the outcome of the presidential election. Ten years ago no one in their right mind could have imagined that $16 trillion of government bonds worldwide would be offered at yields below zero and there was a possibility that Donald Trump would add the White House to his list of residences. Outside of a turbulent January, the U.S. stock market has remained surprisingly calm. The S&P 500 index finished the first nine months of 2016 with a gain of 6.1%. We have to admit that everything seems out of whack. Investors are buying bonds for capital gains and equities for income. Crazy is all we can say.

Many are expecting a volatile fourth quarter, but who truly knows? The approaching election is certain to produce a non-stop stream of predictions from the talking heads. We advise you to tune them out and keep in mind the humorous comment by the legendary economist John Maynard Keynes cited above. Isn't it funny how the same people who get things so consistently wrong never hesitate to leap at the chance to express their views? The point is: even though there is plenty to worry about from an investment perspective, our time is still better spent ignoring fearful forecasts and searching for long-term value. Gloomy sentiment typically creates opportunity.

We'll admit that today's environment is peculiar. In the aftermath of 2008's financial panic, major central banks have attempted to jump start and then sustain an economic recovery by boosting asset prices. Zero percent interest rates are all about forcing people to invest. Unfortunately, a dangerous side effect of the Fed's medicine is the misallocation of capital as evidenced by the steady flow of funds into fixed-income securities sure to generate losses if held to maturity. The ultra-wealthy have also been parking cash in trophy real estate properties; however, the air is starting to leak out of this buy now, flip later trade. Just look at New York City, for example, where a growing supply of apartments for sale is starting to weigh on prices. We do not want to dwell on this subject, but the Fed's focus on liquidity could have a downside. What will occur when the spigot is cut off?

A key positive is that lingering pessimism has kept speculative excess out of the stock market. Bull cycles peak when euphoria is abundant, which is not the case at present. Valuation, while not cheap, remains reasonable, especially when compared to other asset classes. Here at Mercer Capital, it is no secret that we have been inspired by the investment philosophy of Warren Buffett. The Oracle of Omaha would be the first to admit that he has no idea where the market is headed over the short run and wastes zero time thinking about it. He is constantly on the lookout for dominant enterprises that can be purchased at attractive prices. In other words, business quality and price determine investment decisions - not the Fed, elections, and economic forecasts.

A wonderful description of Buffett's mental screen for identifying investment opportunities comes from his confidant and Vice Chair at Berkshire Hathaway, Charlie Munger. His comments below are taped to my desk.

  1. We have to deal in things that we're capable of understanding.
  2. Once we're over that filter, we have to have a business with some intrinsic characteristics that give it a durable competitive advantage.
  3. Then of course, we vastly prefer a management in place with a lot of integrity and talent.
  4. And finally, no matter how wonderful it is, it's not worth an infinite price. So we have to have a price that makes sense and gives a margin of safety, given the vicissitudes of life.

As always, we have our shopping list ready and will be an eager buyer if the stock market falters during the election season. Thank you for your confidence and encouragement. Please call anytime.

9/30/16           Henry D. Mercer III

Index Return (Year-to-Date)   12/31/15 9/30/16
S&P 500 +6.1% Fed-funds .25 - .50% .25 - .50%
DJIA +5.1% 10 yr. T-note 2.27% 1.61%
    Oil (W.T.I.) $37.04 $48.24

* 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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