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By Christopher Davis | 08-19-2011 12:15 PM

U.S. Downgrade Making Euro Crisis Harder to Solve

Fidelity's William Kennedy believes that fears of a debt downgrade are behind European leaders' timid response to the sovereign crisis.

Christopher Davis: Hello. I'm Christopher Davis. I'm a senior mutual fund analyst with Morningstar and editor of Morningstar's Fidelity Funds newsletter. Today, we're joined by Bill Kennedy, the longtime and successful manager of Fidelity International Discovery fund.

Thanks for joining us, Bill.

William Kennedy: Thank you for having me.

Davis: In recent weeks, we have seen fears surrounding the European debt crisis spread. Discussions always surrounded sort of the usual suspects such as Greece, Spain, and Portugal. But more recently investors have worried Italy, even France, might be joining the fray as troubled countries.

This week, on Wednesday, German chancellor, Angela Merkel and the president of France, Nicolas Sarkozy, got together. They hatched the deal that would allow for more integrated Europe, but from a fiscal situation the market really wasn't impressed. Bill, what's your take?

Kennedy: Well, my take is that a lot of the things put out by the governments in Europe, Sarkozy and Merkel, in particular, were little bit vague in nature. The challenge is facing a lot of European countries that need aggressive policymakers making aggressive policy decisions. Merkel's reluctance to issue euro bonds has been troubling for the markets, and really the nature of the European Central Bank, in general, is quite constrained in what it can do to deal with the problem.

So, you have government officials that have not been as aggressive as they should, and you have an ECB that doesn't have the flexibility necessary to offset some of the policy and decisions that are coming out of the eurozone right now.

Davis: I know, Bill, you've been very skeptical of European banks for a long while now, and I can't imagine your skepticism is ebbing. But are there banks out there that investors are just painting with the same brush, that they're painting the more troubled financial institutions in Europe?

Kennedy: Yeah, of course. I mean, if you look at the Nordic banks, for instance, the Nordic countries have great sovereigns; they are in great sovereign situations. You look at the wealth and the fiscal situation of Norway and of Sweden, these countries have really repaired themselves during the last 20 years, since they had a crisis back in the early '90s. Norway, for instance, is blessed with lot of oil, so that country has a very, very strong fiscal situation.

However, the Nordic and the Swedish banks have significantly underperformed major European indexes and global indexes, as a result of the fact that they are banks and they are in Europe. However, they tend to trade at big discounts to where they have historically, and the fundamentals in general tend to be pretty good because those economies have been in pretty good shape. The big issue for them is they have to wholesale fund themselves and the wholesale funding markets in Europe are drying up pretty quickly, given the sovereign crisis further in Southern European countries.

Davis: I know, Bill, you've been able to somewhat escape from European financials by investing in industrial companies, such as BMW and luxury-goods makers, and these companies benefit from global growth, especially in emerging markets such as China. With growth slowing in China and elsewhere really does this leg in the stool kind of fall away, as well?

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