Amid Worries, New Equity Risk Premium Data Explained

The Federal Reserve cut interest rates this past week for the first time since the 2008 financial crisis because of fears the U.S. economy was slowing. U.S.-China trade talks ended with no progress and President Trump announced additional tariffs on Chinese imports, deepening the trade war between the world's two largest economies and the chance of a global slowdown. Meanwhile, Friday's new jobs report showed continuing strength in the U.S. economy's 10-year old expansion, though slower growth could result in a cut in profit expectations in the weeks ahead, as the stock market continued to hover near its all-time high.

Amid the worries investors face, here's a reminder about this important fundamental financial concept.

A rubric of modern portfolio theory taught at colleges and universities holds that investors get paid an extra return for taking risk. The risk premium is the amount you get paid for owning a risky asset.

To quantify the equity risk premium, here are the numbers: Over the 21 years ended June 30th, 2019, the risk-free 90-day U.S Treasury Bill averaged an annual return of 1.94%, compared to a 7.30% annualized return on the S&P 500 stock index, according to economist Craig Israelsen, whose research we license to share with clients and friends.

This 21-year period encompasses two full economic and bear market cycles— the tech-bubble bursting in 1999 and the global financial crisis of 2008— so it is an instructive period to examine.

The difference between the 7.30% average annual return on the S&P 500 index and the 1.94% return on a risk-free T-Bill is 5.36%. The 5.36%— the extra return annually averaged on equity invested in America's 500 largest publicly-held companies in the 21-year period— is the equity risk premium.

In a time of heightened uncertainty, stock investors are tested to accept higher risk if they hope to earn a premium over less-risky Treasury Bills. That's an important financial fundamental to remember in times like these.

After closing at an all-time high of 3,025.86 last Friday, the Standard & Poor's 500 stock index of large public companies, closed about 2% lower to end the week at 2,932.05.

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This article was written by a veteran financial journalist based on data compiled and analyzed by independent economist, Fritz Meyer. While these are sources we believe to be reliable, the information is not intended to be used as financial or tax advice without consulting a professional about your personal situation. Tax laws are subject to change. Indices are unmanaged and not available for direct investment. Investments with higher return potential carry greater risk for loss. No one can predict the future of the stock market or any investment, and past performance is never a guarantee of your future results.

This First Year Under The New Law Requires Planning

The new federal tax code affects the return you'll file in Spring 2019.

The standard deduction, the amount you can subtract from your taxable income if you don't itemize, nearly doubles from $12,700 for joint-filers to $24,000, and from $6,350 for singles to $12,000. That's big.

Fewer than half of those who itemized their 2017 return are expected to itemize in 2018. If you have never used the standard deduction before, preparing your return will be much simpler. A joint-filer with more than $24,000 of itemized deductions will still want to itemize.

If you are still going to be itemizing in 2018, medical expense deductions will be more generous. For tax years 2017 and 2018, medical outlays in excess of 7.5% of adjusted gross income are deductible. However, Congress is considering extending the 7.5% threshold on medical expenses or making it permanent. Stay tuned.

The Alternative Minimum Tax - a despised set of parallel tax rules - will zap fewer Americans in 2018. The AMT started in 1982 as an effort to close loopholes, but it gradually affected more individuals and, in the 1990s, Congress stiffened the AMT rate. Under the AMT, the standard deduction and deductions for state and local income taxes are lost. The AMT exemption is much higher under the new law. Starting in 2019, the threshold income level subject to AMT rises to 10%.

This is an unusual period of adjusting to the new tax law and it requires professional care. Please contact us with your questions.