5 Rules for Post-Recovery Investing

Once the Great Recession is over, it will be a long march back to a fully functioning economy. Here's how to tell which companies are adapting to the emerging world

The Great Depression was long enough and painful enough to form the habits of a generation. The members of that generation became dedicated savers, avoiding debt, paying in cash and keeping both eyes focused on the long run.

The current downturn, what I call the Great Recession, since it is already the longest recession since World War II, will do the same. In the new world that emerges after the recovery, people will save differently, spend differently, look at debt differently and think about the future differently.

Differently how? Well, no one is exactly sure. It's awfully hard to figure out a change like this in the midst of it. But be sure of this: Every company in the global economy that doesn't have its head stuck in the sand is trying to figure out this new world. And for investors, getting it right -- owning shares in the companies that are in tune with this emerging world and avoiding the shares of those that do business as if nothing has changed -- will be the difference between profit and loss in the decade ahead.

How long down, not how far

In this column, I'm going to summarize some of the evidence pointing to the emergence of a new world and sketch out some of the current attempts to define how that world will be different. I'll end with five rules of thumb for finding the stocks that will do best in the post-recovery world.

The case for a new post-recovery world hinges on a simple argument: It's the duration, rather than the absolute magnitude, of a downturn that produces changes in habits like those seen in the Great Depression.

There's no way that the Great Recession can match the Great Depression in terms of the severity of the downturn. Official unemployment in the Great Depression peaked at 25% of the work force. Right now it looks like official unemployment in the Great Recession will top out at 11% or so.

Great Depression's drawn-out recovery

At first glance, the Great Recession doesn't look like it holds a candle to the Great Depression on duration either. The current downturn officially began in December 2007. That puts us now, in April, in month 17. That's long as recessions go.

As you can see from the chart below, the Great Recession would be the longest recession since World War II even if it ended tomorrow.

That's still much, much shorter than the Great Depression. But then, the Great Depression was itself shorter than most people think. By many accounts, the U.S. economy had plunged into a depression by 1930 and moved to recovery by 1933.Long enough, thank you. But the Great Depression seemed much longer than that because the recovery was so anemic and was punctuated by huge setbacks. The U.S. economy may have resumed its growth in 1933, but gross domestic product didn't recover to the 1930 level of $97 billion until 1940. The recovery was so slow that, even though the economy was growing, to many people in the United States it seeme like the Depression stretched on and on and on.

Back on its feet in 2015 -- but not sprinting

And, many economists project, that's exactly how we're going to feel about the recovery from the Great Recession. The Congressional Budget Office predicts the U.S. economy won't return to full-trend growth until 2015. And full-trend growth -- sustainable economic growth without rising inflation -- even then isn't going to be what it was before the global financial crisis.

The Federal Reserve, which I'd place among the optimists on this issue, says full-trend growth isn't going to be the 3% annually of the pre-crisis economy but more like 2.5% or even as low as 2%. Harvard University economist Dale Jorgenson, who taught Fed Chairman Ben Bernanke, projects just 1.6% annual growth through 2030.

If Jorgenson is anywhere near correct, the Great Recession would make the Great Depression seem like a picnic to many people.

Is there any reason to think these projections might be right? Unfortunately, a lot of evidence argues in favor of a very slow and tepid recovery:

• In the boom, the economy got the benefit of the wealth effect as families spent part of the gains in the value of their houses and investment portfolios. Now the economy is facing a negative wealth effect as lower home values and smaller investment portfolios cut into household spending. Household net wealth was down 20% from mid-2007 to the end of 2008.

• Like U.S. businesses, American families are going to have to deleverage their balance sheets by paying down debt. That means having less to spend on consumption. Household debt had climbed to 130% of income by the end of 2008.

• Losses in the financial sector of an estimated $2 trillion (only $1 trillion realized to date) will cut the amount of capital available for lending and raise the price of that capital.

• Any recovery will send the price of oil and other raw materials higher, which will act as a drag on the economy. Taxes will climb as governments around the world try to repay some of the debt they had piled on to end the crisis. In the United States, interest rates will climb as overseas investors demand a better return on all the U.S. debt they hold.

• Finally, many companies used cheap money to offer incentives to keep their customers buying. Even in a recovery, sales won't bounce back to boom-year levels.

Spending shift already under way

All this is important because economic trends of long duration change consumer behavior -- and change it for long periods. The boom years before the 1929 stock market crash saw an expansion of consumer borrowing much like what we saw before the current financial crisis. The Great Depression ushered in a long period of low and slowly growing debt. That finally gave way to another period of rapid growth in debt -- which now is likely to have come to an end.

It's not just how much money consumers spend but what they choose to spend it on. Pick just about any industry you want and you can find anecdotal evidence of long-term trends in the way consumers define value that reflect underlying long-term economic trends.