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By Jeremy Glaser | 12-15-2011 11:00 AM

Finding High Ground During the European Debt Crisis

We don't know what the end game in Europe is yet, but these firms should be able to withstand the flood, says Morningstar's Paul Larson and Dave Sekera.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Finding high ground in the European sovereign debt crisis, I am here today with Dave Sekera, our bond strategist, and Paul Larson, our chief equity strategist. We'll take a closer look at the crisis and also offer some investment ideas.

Gentlemen, thanks for joining me today.

Dave Sekera: Good to be here, Jeremy.

Glaser: So, Dave, let's actually start by taking a look at this crisis that it seems to be neverending. Can you just give us a little bit of background about exactly how long this has been occurring?

Sekera: Well, you know, it really started in the spring of 2010 when we first started to see some rumblings in Greece. We saw that it had some accounting issues, and we saw that the gross domestic product was really a lot higher than what people had expected. The bonds started to sell off, and we've all lived through this since then. Here it is the end of 2011, and we're finally starting to take at least some of the right steps going into 2012.

We've seen a lot of different bailout measures that the different governments in the European Union have tried to implement. We've written for a long time now that they've been providing liquidity, doing the right thing to keep the markets moving along, but they really have never addressed the underlying causes of the problems, really the solvency of the individual sovereign nations that are at risk and the potential contagion to the banks.

Glaser: So, if we're maybe just now getting started as far as underlying issues, let's talk about what are some of the potential outcomes are. We might not know exactly what's going to happen, but what are some scenarios, what are some end games of how this crisis finally comes to an end?

Sekera: Sure. As we are going into 2012, we just had the most recent December summit, and in this summit the real agreement that the EU leaders came to is that they're going to start improving the fiscal discipline of the individual nations and start addressing a lot of the structural issues.

So that's going to give us a lot of headwind going into 2012 as they start looking at cutting some of the deficits in those countries and start looking at some additional austerity measures. And then, they also have to put some structural issues in place in order to, for example, work on some of the work rules within the different countries and address the current account balances in those countries.

So I think probably the best that I would expect would just be another muddle-along kind of scenario, probably a low-growth to no-growth environment across the eurozone as a whole. A country such as Germany, which has higher productivity, should still be able to eke out a couple percent of real GDP growth, but some of the other countries I do think are in for potentially a bit of a recession.

So the real question is if we are going into recession in Europe. Of course, we don't really have any better insight because we don't rate sovereign debt here at Morningstar; we really stick with the corporate credit as a fundamental bottom-up analysis. But for a recession, is it just really more of a typical recession, a garden-variety, or are we looking at what could be a deep and protracted long-term recession in Europe?

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