QUARTERLY LETTER

Year End 2009 — Investment Strategy Review

“More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have the wisdom to choose correctly. ”
                                          — Woody Allen


A decade which began with a ton of optimism has ended with abundant pessimism. The contrast between the eras is startling. Ten years ago investors were swept up in the euphoria produced by one of history’s greatest bull markets. Today they are disillusioned after being pummeled by two massive declines, the 2000-2002 technology bust and the devastating panic of 2008. The S&P 500 has posted a loss for the decade — opening at 1469.25 and closing at 1115.10, a reminder that valuation determines stock prices over the long-term. In late 1999, the index was trading at an all-time high price-to-earnings ratio, so the dismal return is not surprising. As shown by the table below, the major U.S. equity indices experienced one of the rare instances when they have been outclassed for an extended period by T-bonds, and even gold.

Index12/31/9912/31/09
S&P 5001469.251115.10
DJIA11497.1210428.05
Nasdaq4069.312269.15
T-bond yield6.48%4.63%
Gold$288.50$1,095.20

Ironically, 2009 was a superb year for the stock market, which is hard to fathom considering how rotten it began. Stocks are in the midst of a spectacular rally fueled by the Fed’s rescue measures. The S&P 500 has soared 64.8% since bottoming in March, leaving it with a 23.5% gain for the year. Nevertheless, despite the huge bounce, the index is still 10.9% below where it was the day Lehman Brothers died, and 28.7% below the October 2007 record high. Investors may feel relieved, but this is not a New Year’s to be popping celebratory champagne corks — unless you have been doing “God’s work” at Goldman Sachs.

Looking out into the future, we are enthusiastic about the stock market’s long-term prospects. Everyone knows the risks — high unemployment, deficits, the dollar, deleveraging, home prices, commercial real estate, protectionism, terrorism…we could go on and on. Investing, however, does not reward conventional wisdom and we have never witnessed a time when people were as pessimistic about the path of the United States. The gloom is so thick that it is reminiscent of the Woody Allen line cited above. We do not intend to joke about the situation, but the fear seems overblown. As contrary investors, we think the pessimism enveloping the U.S. is bullish. U.S. corporations, on balance, remain powerful and innovative, and the shares of the best of them are reasonably priced. Many international stock indices have been winners over the decade, and without question, the big story has been globalization and the blossoming of the emerging markets, but this does not mean that the U.S. will continue to lag.

As opposed to ten years ago when the U.S. stock market was way overvalued, it begins this decade much cheaper. In fact, at the March low, stock prices here were an absolute bargain. Trends do not last forever and probability favors that U.S. equity indices will break out of the doldrums. The S&P 500 recently moved back above 1100, a level it first crossed in 1998, and many are saying that it will remain range bound for years to come. Odds do not favor this bearish scenario.

Our job is not forecasting, but rather the prudent allocation of your investment capital. By now you are aware that Mercer Capital’s philosophy is centered on the concept of “margin of safety” and this has provided protection during the worst of times. We are confident that your portfolios will prosper during what should be a better decade ahead. Old dogs can learn new tricks and we will work hard to evolve as investors and expand our focus. We will not, however, abandon our value bias. Look for us to continue to buy shares in dominant businesses only when they are available at discounted prices.

Thank you for your confidence and support. We hope that you have a happy, healthy, and profitable 2010.

12/31/09           Henry D. Mercer III

Additional Comment – One thing that gets lost in the background of the investment world’s obsession with the stock market is the tremendous secular bull cycle experienced by U.S. Treasuries. The 10 year T-note yield peaked at 15.84% back in 1981 and fell to a low of 2.08% in late 2008. Historically, interest rate cycles have gone through multi-decade swings, so the long-term decline in bond yields is not unusual. Investors need to be prepared for the possibility that the secular bull market in U.S. Treasuries may be over and that yields will begin a gradual increase lasting many years ahead. Imagine what Wall Street would have been like without this bond rally — no 1982-2000 bull market for stocks, no billion dollar paydays, no Gordon Gekko, no Bonfire of the Vanities, no Long-Term Capital, no housing bubble, no CNBC…The leverage pyramid which collapsed in 2008 was built on the foundation provided by the ease of borrowing cheaply. Food for thought…

Index2009 ReturnKey Int. Rates12/31/08 12/31/09
S&P 500 + 23.5% Fed-funds0 - .25%0 - .25%
DJIA + 18.8% 3 mo. T-bill.11% .06%
  10 yr. T-note2.25% 3.83%

* 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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