QUARTERLY LETTER

4th Quarter 2013 — Investment Strategy Review

“It’s a basic fact of life that many things “everybody knows” turn out to be wrong. ”
                                          — Robert Shiller


The bulls were rewarded in 2013 as the U.S. stock market rallied throughout the year. Twelve months ago investors were worried about a number of issues ranging from the fiscal cliff to the tapering of the Federal Reserve’s quantitative easing program, but none of them halted the market’s upward charge. The major indices surged to a series of record highs; the S&P 500, for example, closed out 2013 with an impressive gain of 29.6%. As noted in previous letters, we believe equities have entered a secular bull cycle that will generate attractive returns in the decade ahead, but this does not mean that the ride will be as smooth as 2013’s. Corrections occur even during the most powerful advances, so investors should expect their resolve to be tested next year. Here is a quick summary of some key factors that have raised the odds of a near-term decline:

  • Quantitative easing has provided the rationale for hedge funds to load up on stocks. The Fed began to scale back its bond-buying in December and the acceleration of this process would deliver an excuse to take profits. Incoming Fed Chair, Janet Yellen, faces the tricky task of guiding an economic and financial system addicted to monetary painkillers. History shows that transitions of Fed leadership are not always seamless. Alan Greenspan was greeted with the 1987 crash.
  • Investor psychology has become too bullish. The big rally has eliminated the rampant fear caused by 2008’s panic. It is far better to buy when investors are frightened, not when they are cheerful. Surveys of investor sentiment are discovering lots of bulls and few bears, a huge change from a year ago. We would prefer to see more pessimism.
  • Newspaper front pages are also capturing the uplift in investor spirits, a bad contrary omen. On Christmas Eve, USA Today ran the following headline: “Santa Claus Rally Is Real.” Furthermore, Time magazine recently featured controversial investor Carl Icahn on its cover with the headline: “Master of the Universe.” Perhaps no investor has symbolized greed more than Icahn. Today he is politely called an “activist,” but we remember when he was reviled as a corporate raider. His exalted status is bearish.
  • The mania for social media stocks is reaching bubble-like proportion. Twitter shares have skyrocketed since coming public in November. Not bad for a company that produces no earnings. This speculative activity is reminiscent of the late 1990’s excesses. All we can say is, buyer beware.
  • 2014 is a mid-term election year and the stock market has often experienced sizeable corrections during the first nine months. The good news is that these declines tend to provide launching pads for major advances.

Here at Mercer Capital our job is the rational deployment of capital, not forecasting. The biggest challenge in the years to come will be providing a margin of safety in an environment where bonds, a traditional diversifier, have zero appeal. Many investors are not old enough to recall the damage that can be inflicted on fixed-income portfolios during periods of rising interest rates. 2013 gave them a taste. Equities will to have to play an even bigger role in our investment strategy. This does not mean abandoning our value philosophy, which is why a correction in 2014 would be beneficial. We are eager to buy, but our discipline requires cheaper prices.

By now you are well aware that we seek to invest in superior businesses that possess durable competitive advantages and then cling to them for the long-term. Great companies are rare which forces us to be selective. In 2013 we spent countless hours thinking about the key characteristics of outstanding enterprises and are confident that this effort will pay off when new ideas are purchased in the future. Lastly, we are diligently searching for outfits run by CEOs that are gifted in the art of capital allocation and unselfishly focused on building shareholder value. You should expect to see investments incorporating this theme in the New Year.

Thank you for your encouragement and support. We hope that you have a happy and prosperous 2014.

12/31/13           Henry D. Mercer III

Index 2013   12/31/12 12/31/13
S&P 500 +29.6% Fed-funds 0 - .25% 0 - .25%
DJIA +26.5% 10 yr. T-note 1.76% 3.03%
    Oil (W.T.I.) $91.82 $98.42
    Gold $1,674.80 $1,201.90

* 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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