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By Matthew Coffina, CFA | 11-11-2014 04:00 PM

Coffina: How to Handle 5 Risks in the Market Today

Morningstar strategist Matt Coffina discusses how he views interest rate, geopolitical, regulatory, currency, and valuation risk when managing the StockInvestor portfolios.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

I'm here today with Matt Coffina, the editor of Morningstar StockInvestor newsletter. We're going to look at some risks that investors are seeing in the market today and how they should think about them.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: One of the risks investors seem to be most worried about today is the Federal Reserve and when rates are going to rise, or if they are going to rise faster or sooner than the market is expecting.

What's your take on this? Are you worried about how rising rates could impact your portfolio holdings?

Coffina: Interest rates are definitely one of the biggest risks that we face and one of the most unavoidable. For us, our interest rate risk is particularly acute in the Tortoise Portfolio, where we tend to own larger, more steady, slower-growing, less economically sensitive businesses, often with relatively higher dividend yields. So, companies in consumer staples, health care to a certain extent, midstream energy, utilities, real estate investment trusts. These kinds of companies tend to be much more sensitive to interest rates.

On the other hand, we also own a couple of companies, Charles Schwab and Wells Fargo come to mind in particular, that would benefit from higher short-term interest rates, and I think it's nice to have a couple of names like that in your portfolio to balance out the general interest rate risk, which is usually that higher interest rates are bad for equities--or at least that's what's perceived.

The other side of the story, though, is that if the Federal Reserve is raising interest rates, it's a good bet that the economy is showing some strength, that maybe unemployment is falling faster than was expected, that GDP is growing better than was expected, and that's a good thing for stocks in the long run, in my view. A stronger economy means higher cash flows, and that usually is more than enough to offset the potential for a higher discount rate that comes with higher interest rates. So overall, I don't think higher interest rates are all bad, especially if they're associated with a stronger economy.

Then the other thing I always like to ask myself is, is this going to matter in 10 years? I think the reality is that if the economy continues to grow at a decent pace, more consistent with the long-run historical average, you expect interest rates to eventually normalize at, call it 3% to 5%, a more normal kind of level--maybe 2% inflation plus the 2% real return. And I think that's healthy. Whether we get there next year or two years from now or five years from now, I think that's where we're headed in the long run.

I'd be much more concerned if we were in a situation where interest rates stayed at 2% or 3% indefinitely, because that probably means the economy is stagnating, maybe we're facing an ongoing risk of deflation, we're more in a Japan kind of scenario, and that certainly wouldn't be good for common stocks.

Glaser: How do you think about geopolitical risks today? There are lots of bad headlines out of the Middle East, fears over things like Ebola. Do you take any of these into account when you're considering investments? Is this something that investors should really be thinking about when making portfolio decisions?

Coffina: There is no shortage of scary headlines, but I think they're really more concerning from a humanitarian standpoint than they are from an investor's standpoint.

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