Spanish Bank Woes Posing Greater Risks

With things relatively quiet in Greece as politicians there gear up for the upcoming election later this month, investors have turned their gaze to Spain as worries about that country took center stage. Spain is farther away from the precipice than Greece, but its problems are still acute and could very well spill over into the global financial system. Investors looking for safety might be hard-pressed to find it anywhere, but over the long haul, companies with great competitive advantages and sterling balance sheets are likely to hold up better in a crisis than more speculative names and other seemingly safe assets.

Spain's banking system is in a tough spot. The banks are quite wobbly because of the burden of bad loans, an increasingly skittish deposit base that is looking to move cash to more stable banks in Germany and elsewhere, and a bleak economic outlook. The highest-profile case has been Bankia, which Spain has now partially nationalized and is now planning to sink about EUR 19 billion into in order to keep the institution afloat. 

If this were the only payment that needed to be made, this news wouldn't be that worrying. But bailouts have a funny way of multiplying. The core weakness of the banking system can't be addressed until the core of the European problem is addressed. Until depositors are confident that Spain isn't going to leave the euro, they are going to keep seeking safer ground, and without more certainty the Spanish economy is unlikely to improve anytime soon. And it isn't even clear that Spain will be able to raise the money needed for all of the future bailouts. More loans from the International Monetary Fund and others might be needed. Investors (are rightly) worried that the banking system will become a black hole that will just further compound existing sovereign debt problems.

Add in worries about the strength of Spain's regional governments (each of which had a fair amount of budget autonomy), the still-sky-high unemployment rate, and the painful competitiveness adjustments that need to occur in the country, and it doesn't paint a pretty picture. A Greek exit from the eurozone or a sudden uptick in the flow of assets out of the country could very well accelerate the crisis in Spain. Spain is more important to the world and European economy than Greece is, and a collapse of its economy would make big waves. As we learned in 2008, a financial shockwave can have unexpected consequences and can negatively affect the institutions across the globe. The truth is, we don't know for sure what will happen if the crisis gets much worse, but there is a real chance that global financial system could be put under immense pressure yet again.

These systemic worries sent investors scurrying for safe-haven investments this week. Yields on U.S. Treasuries, German bunds, and other sovereign debt viewed as strong hit record lows as money flowed into those markets. Investors are saying they are willing to accept what will likely be a negative real yield during the next decade in order to avoid the potential storm in Europe. Preservation of capital is certainly an admirable goal, but investors with a longer-term time horizon are setting themselves up for failure if they accept that anemic return for years to come.

Stocks Likely to Withstand Eurozone Troubles
For investors who can handle the short-term volatility, equities look like a stronger bet at the moment. It will certainly be a bumpy ride. In a crisis the entire market sells off regardless of the quality of the underlying businesses making it difficult to create an iron-clad equity portfolio. However, the upside of this is that it means that many great businesses could be available for a fraction of their intrinsic worth. When you buy on the cheap, good businesses tend to do wonders for your long-term returns.

Stock selection is very important here. You need to make sure you are buying business that can withstand the crisis and that won't be permanently impaired by a new banking dilemma. This translates into looking for companies with strong economic moats (competitive advantages) and very solid balance sheets. Using Morningstar's  Premium Stock Screener tool, we screened for cheap stocks to which Morningstar analysts have assigned a wide moat. We also added a screen for stocks that have a low fair value uncertainty rating, a sign that the analyst sees the range of possibilities for the firm to be fairly narrow and that a major blowup is a very remote outcome. You can run this screen for yourself  here.

None of the companies that passed the screen are screaming buys at the moment. However, they might be great additions to your watchlist. If stocks continue to tumble as they have been, these might be good names to add money to when buying on the dip and a way to make the best of the eurozone crisis. Below are three names that passed.

 3M (MMM)
From the  Premium Analyst Report:
Over its long history, 3M has invented some of the world's greatest products. We think the firm's innovative culture, bottom-line focus, and low-cost manufacturing have carved a wide moat around its business that will enable the company to reap outsized rewards over the long run. That said, the company tends to feel the pinch of economic slowdowns relatively early, and near-term headwinds could crimp the firm's results for several quarters.

 Boardwalk Pipeline Partners
From the  Premium Analyst Report:
In the midstream master limited partnership universe, Boardwalk Pipeline Partners differentiates itself with an attractive pure-play interstate pipeline network in the heart of top unconventional natural gas shale plays. We think these long-haul pipelines will yield steadily growing cash flows for years to come.

 Johnson & Johnson (JNJ)
From the  Premium Analyst Report:
Johnson & Johnson stands alone as a leader across the major health-care industries. The company maintains a diverse revenue base, a robust research pipeline, and exceptional cash-flow generation that together create a wide economic moat.