Just found this letter on the web from Zeal. Link is...

Just found this letter on the web from Zeal. Link is http://www.zealllc.com/2009/pstpanic.htm

Due to the size of the article I have cut and pasted the relevant area for peoples information. I for one expect the US market to be higher in Dec 2009 than it was on on Dec 31 2008.

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Many people think we are entering a new Great Depression today. If that is the case, then 2009 will indeed be bad. But I don’t see a neo-Great Depression emerging for a wide array of reasons, as I discussed in depth for our subscribers in the 12/08 issue of Zeal Intelligence. The primary reason is the Great Depression saw the US economy literally cut in half between 1929 and 1933. Even the most raging bear today doesn’t expect US economic output a few years from now to be half of 2007’s levels.



To get to half, US GDP needs to shrink by 15.9% annually over each of the next 4 years or 20.6% annually over each of the next 3. It ain’t gonna happen. A panic is a fear event, nothing more. The economy may contract by 1% to 3% annually for a couple years on the outside, but there is no way we will see Depression-like economic contractions. If you study the Great Depression, you’ll probably categorically dismiss the chance of a similar event today. It was totally unique and driven by conditions radically different than 2008’s.



So yes, during that Great Depression era there were big down years followed by big down years. But this occurred nowhere else in stock-market history. Year after year of double-digit economic contraction certainly warranted such an outcome. Today even the raging pessimists think 2009’s overall economic growth will be flat to mildly negative. So I think we are justified in excluding the Depression years from this analysis.



Ex-Depression, after 20%+ down years the average DJIA gain in the subsequent year was 25.3% across 7 episodes. The worst year was 1894’s 0.6% loss following 1893’s 24.6% loss. Every other subsequent year was positive, with only 2 being in the teens and 4 seeing big gains over 28%. So unless you are betting on a neo-Great Depression, you are fighting history if you expect 2009 to be down. 123 years of history suggests it will be up big, at least the 25% average of all such years outside of the early 1930s.



Among these historical episodes, perhaps the most relevant to today is the infamous Panic of 1907. It was the most famous event in market history until the Great Depression, even though most investors today aren’t aware of it. In 1907 the DJIA plunged 37.7%. As the next chart shows, this decline looked uncannily like today’s. Then in 1908, despite the widespread fears in late 1907, the DJIA soared 46.6%.





Realize there is no trickery in this chart. Both axes are zeroed so that there is no distortion in the relative slopes of the DJIA in 1907 (when it had 12 stocks) and the Dow 30 in 2008. The resemblance of these two panics, separated by the vast gulf of a century, is uncanny. I am sure I could pass one chart off for the other and almost no one would be the wiser. This pair of panic events was incredibly similar.



How can this be? The markets are vastly different today than 101 years ago. Very true. But one thing that hasn’t changed is human emotions. Greed and fear drives speculators today just like it did a century ago. The interaction of these emotions with herd psychology works the same way today as it did back then. A 10% or 20% selloff episode in those markets was just as scary to those investors as a similar decline is to us today.



In October 1907, a major brokerage (Gross & Kleeberg) collapsed after a stock-cornering speculation scheme failed. In September 2008, a major investment bank (Lehman Brothers) collapsed after a hyper-leveraged real-estate speculation scheme failed. Both events led to a cascading loss of confidence among investors and bankers, the latter becoming too frightened to lend resulting in credit becoming scarce. Then selling begot more selling, mushrooming the panics, until everyone remotely interested in selling had sold.



Both panics had tops in October of the previous year (on the very same day, October 9th!). Both had similar cascading selloffs in the panic year before the panic erupted in October. Both had similar sharp panic plunges in October and November. Both bottomed in November (1907 on the 15th, 2008 on the 20th). Both saw similar peak-to-trough losses over that entire sliding year (45.2% in 1907 and 46.7% in 2008). Both felt like the end of the world at the time, and both helped drive sharp economic contractions. The parallels in time and selloff magnitude are amazingly similar.



But after its November 1907 bottom, that panic started to gradually recover despite horrendous sentiment. It even saw a couple of sharp pullbacks after this recovery stealthily started. In 8 days in December 1907, the DJIA retreated 8.0%. I’m sure that scared traders into thinking the panic wasn’t over yet. In January 1908, there was a second 6.9% pullback in 8 days.



These are provocative as we’ve just seen a January 2009 DJIA pullback of 9.0% in 6 days and everyone is freaking out. But it looks like par for the course. The initial recovery out of panic lows is during a time of great uncertainty and residual fear, so it is not just a nice smooth climb back to normalcy. As usual in an uptrend, the stock markets take two steps forward then one step back. November 2008 to January 2009 fits this post-panic pattern perfectly.



Of course over the next year following the November 1907 panic lows, the DJIA surged 66.8% higher! It peaked on November 13th, exactly one year after the panic low (the 15th was a Sunday). This recovery rally was enormous and exceedingly profitable for those brave contrarian souls who bought in the midst of the panic at the depths of popular despair. And this big rally happened despite the economy not expanding again until Q3 1908. It’s a fascinating and encouraging parallel, no?



Everywhere you look today, Wall Street and market professionals expect 2009 to be flat to horrible. The economy is not recovering, they claim. Yet history shows the markets really don’t care outside of a Great Depression-like catastrophe. Stock markets recover sharply after big down years even if the economic recovery takes longer to arrive.



As a hardcore contrarian, I expect 2009 to follow this big-recovery-rally pattern so I am fighting the crowd and going heavily long. Odds are 2009 will be awesome. In late December I wrote to our Zeal Speculator subscribers regarding the SPX, “…2009 should be outstanding for the US stock markets. I suspect a 25%+ year is virtually a certainty. And a 50% year would not surprise me one bit.” I still believe this today.



At Zeal, we do all our own original research. We are not swayed by popular opinion and we don’t care what people think. We study the markets ourselves to define probable outcomes and then trade accordingly. If you are tired of the endless Wall Street groupthink, and running with the hysterical herd emotionally, give our acclaimed monthly newsletter a try. We’ll illuminate today’s markets for you based on history and show you what specific trades we are making to capitalize on these opportunities. Subscribe today!



The bottom line is stock-market history is crystal clear on post-panic stock years. Big down years are almost always followed by really big up years. The only major exception is the Great Depression, when the US economy was cut in half. If you don’t expect a 50% economic contraction today, then the only sound bet to make based on market history is for a massive up year in 2009. We are talking 25% up to maybe even 50% gains in the SPX!



It may be hard to believe a great year is even possible today, but things always look bleak emerging out of a panic. Residual fear lingers a long time, actually until stock indexes finally rise far enough to fully dispel it 6 months or so later. Stocks rebound way before the underlying economy finally starts to recover. Going long right after a panic is the ultimate contrarian bet, very challenging psychologically but promising huge potential rewards.



Adam Hamilton, CPA January 16, 2009 Subscribe