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The Economy Is Scary. Here's What We Can Gather From History

Crumpled dollar bill
James Martin/CNET

This story is part of So Money (subscribe here), an online community dedicated to financial empowerment and advice, led by CNET Editor at Large and So Money podcast host Farnoosh Torabi.

What's happening

Economic headwinds are prompting questions about whether the US is headed into a recession.

Why it matters

Periods of financial volatility and economic decline can drive people to panic and make costly mistakes with their money.

What's next

Examining what's happening now -- and comparing it with the past -- can provide crucial context for investors and consumers contemplating their next step.

A majority of Americans are expecting bad times in the year ahead. And who can blame them? 

Prices for everyday essentials have been rising across the country, mortgage rates are going up, the price of gas is sky-high and stocks are falling, with no relief in sight. US households have widespread concerns over rapidly declining living standards, according to the most recent Surveys of Consumers index from the University of Michigan. Comparable to bleak times during the 1980 recession, consumer sentiment is at an all-time low. 

Numerous economic experts are raising the possibility of a recession, or even a coming period of stagflation, defined by rising rates, high unemployment and slow economic growth. The ripple effect is real: Earning, saving and investing money become more difficult, leading to financial stress and panic.

At a time like this, we should consider what happens in a recession, look at the data to determine whether we're in one and identify ways to maintain some historical perspective. It's also worth pointing out that down periods are temporary and that, over time, both the stock market and the US economy bounce back. 

I don't mean to minimize the gravity and hardship of the times. But it can be useful to review how the economy has behaved in the past to avoid irrational or impulsive money moves. For this, we can largely blame recency bias, our inclination to view our latest experiences as the most valid. It's what led many to flee the stock market in 2008 when the S&P 500 crashed, thereby locking in losses and missing out on the subsequent bull market. 

"It's our human tendency to project the immediate past into the future indefinitely," said Daniel Crosby, chief behavioral officer at Orion Advisor Solutions and author of The Laws of Wealth. "It's a time-saving shortcut that works most of the time in most contexts but can be woefully misapplied in markets that tend to be cyclical," Crosby told me via email. 

Before you make a knee-jerk reaction to your portfolio, give up on a home purchase or lose it over job insecurity, consider these chart-based analyses from the last three decades. We hope this data-driven overview will offer a broader context and some impetus for making the most of your money today.

What's happening with mortgage rates? 

30-year fixed-rate mortgage averages in the US

Current conditions: As the Federal Reserve continues its rate-hike campaign to cool spending and tame inflation, the rate on a 30-year fixed mortgage has jumped annually by nearly 3 percentage points to almost 6%. In real dollars, that means that after a 20% down payment on a new home (let's use the average sale price of $429,000), a buyer will roughly need an extra $7,300 a year to afford the mortgage.  

The context: Three years ago, homebuyers faced similar borrowing costs and, at the time, rates were characterized as "historically low." And if we think borrowing money is expensive today, let's not forget the early 1980s when the Federal Reserve jacked up rates to never-before-seen levels due to hyperinflation. The average rate on a 30-year fixed-rate mortgage in 1981 topped 16%.   

The upside: For homebuyers, a potential benefit to rising rates is downward pressure on home prices. As the cost to borrow continues to increase, homes will likely experience fewer offers and prices may fall. In fact, nearly one in five sellers dropped their asking price during late April through late May, according to Redfin

What about the stock market? 

Dow Jones Industrial Average stock market index for the past 30 years

Chart showing 30 years of macrotrends for the Dow Jones Industrial Average
Macrotrends.net

Current conditions: Year-to-date, the Dow Jones Industrial Average -- a composite of 30 of the most well-known US stocks such as Apple, Microsoft and Coca-Cola -- is about 14% below where it started in January. Relative to the broader market, technology stocks are down much more. The Nasdaq is off more than 21% since the start of the year. Earlier this month, the benchmark S&P 500 recorded a 20% drop from January, bringing us officially into a bear market. As workers return to the office and people move away from digital back toward in-person experiences, analysts say the bubble is bursting for companies like Amazon and Netflix whose profits ballooned during the pandemic. 

The context: Today's losses are not nearly as swift and steep as we saw in March 2020, when panic over the pandemic drove the DJIA down by 26% in roughly four trading days that month. The market, however, reversed course the following month and began a bull run lasting more than two years, as the lockdown drove massive consumption of products and services tied to software, health care, food and natural gas. 

Prior to that, in 2008 and 2009, a deep and pervasive crisis in housing and financial services sank the Dow by nearly 55% from its 2007 high. But by fall 2009, it was off to one of its longest winning streaks in financial history. 

The upside: Given the cyclical nature of the stock market, now is not the time to jump ship.* "Times that are down, you at least want to hold and/or think about buying," said Adam Seessel, author of Where the Money Is. "Over the last 100 years, American stocks have been the surest way to grow wealthy slowly over time," he told me during a recent So Money podcast.

*One caveat: If you're closer to or living in retirement and your portfolio has taken a sizable hit, it may be worth talking to a professional and reviewing your selection of funds to ensure that you're not taking on too much risk. Target-date funds, a popular investment vehicle in many retirement accounts that auto-adjust for risk as you age, may be too risky for pre- or early retirees.  

What do we know about inflation? 

Historical inflation rate by year

Chart showing inflation levels since the late 1970s
Macrotrends.net

Current conditions: The US is experiencing the highest rate of inflation in four decades, driven by global supply chain disruptions, the injection of federal stimulus dollars and a surge in consumer spending. In real dollars, the 8.6% rise in consumer prices is adding over $300 more per month to household budgets. 

The context: Policymakers consider 2% to be a "normal" inflation target. The country's now experiencing four times that figure. It is the largest jump in annual inflation since 1980 when the inflation rate tapped 13.5% following the prior decade's oil crisis and high government spending on defense, social services, health care, education and pensions. The Federal Reserve increased rates to stabilize prices and, by the mid-1980s, inflation fell to below 5%.

The upside: As overall rates jump, the silver lining may be that we'll see personal savings rates inch higher. Bank accounts are starting to offer more attractive yields, while I bonds -- federally backed accounts that more or less track inflation -- are attracting savers, too. 

What does unemployment tell us? 

US unemployment rates

Current conditions:. The May jobs report shows unemployment holding steady at 3.6%, well above the lows seen in February and March of 2020. The Great Resignation of 2021, where millions of workers quit their jobs over burnout, as well as unsatisfactory wages and benefits, has left employers scrambling to fill positions. In many ways, it is a job-seeker's market.

The context: The rebound in the unemployment rate is an economic hallmark of the past two years. But the ongoing interest rate hike may weigh on corporate profits, leading to more layoffs and hiring freezes. In particular, the tech sector is one to watch. After benefiting from rapid growth led by consumer demand in the pandemic, companies like Google and Facebook may be in for a "correction." The layoff tracking website Layoffs.fyi shows that close to 70 startups and tech firms downsized in May.  

The upside: If you're worried about losing your job because your employer may be more vulnerable in a recession, document your wins so that when review season arrives, you're ready to walk your manager through your top-performing moments. Offer strategies for how to weather a potential slowdown. All the while, review your reserves to see how far you can stretch savings in case you're out of work. Keep in mind that in the previous recession, it took an average of eight to nine months for unemployed Americans to secure new jobs.