It is important to review what Greece was and what it was not. The Greek saga (which is far from over, though momentarily off the picture) is a clear symptom of un-finished business in the Eurozone, a picture of what is unsustainable about the ‘European project’. The Greek saga has also been a distraction from what really matters in the short to not so distant medium term: fundamentals and policy that have a global and broad impact on growth. In other words, the normalization of monetary policy in G7 (for now in the US and UK), as well as fundamental questions about the nature of the global business cycle (especially the debate on productivity growth). This is clearly a collection of complicated issues, which we try to overview somewhat superficially in the interest of time/space.

By now it is generally accepted that Greece is not relevant per se, but as a signal of what could happen in the Eurozone more generally. So far the European Project was based on the principle of irreversibility, despite the fact that its institutional setup was still unsustainable. It continues to be unsustainable, but it is no longer irreversible.

The euro would be sustainable once the monetary union is truly complemented with a more profound economic union, and possibly further political union. In simplistic terms, it is difficult to share a currency when banks and taxation are not truly shared. A lot has been done recently to advance the banking side, with the ECB taking on the regulatory role. But the Greek crisis shows the banking systems are not integrated, when banks have to close when the government is in a fiscal crisis. If Mississippi or Alabama were to default, banks in those states would almost certainly continue to function normally. When California was in fiscal troubles, their banks were not less credible than New York banks. Europe is very far from such level of integration, mostly because there is no European fiscal authority with regional taxation powers. Again, in simplistic terms, unless Germans get to collect taxes in Greece, the monetary union will remain unsustainable in fiscal and financial terms. Obviously, a less simplistic view would focus on the complicated institutional setup that such fiscal integration requires in terms of local fiscal rules, etc.

Competitiveness is a separate issue, but one that is obviously relevant in the cases of Greece and other periphery countries. Again, the euro would remain unsustainable as long as countries have massively different productivity profiles as a result of different regulatory schemes and other economic rules and institutions (and reject permanent subsidies, as they implicitly occur in the US). Further integration is needed, and if the Greece saga serves to accelerate integration, then maybe Greece can have an exaggerated effect again, but this time on the positive side.

China was the other shock these last few weeks, with its stock market suffering a large sudden selloff after months of outperformance. Whether that selloff is an indication of a serious underlying fundamental problem that will produce a harder landing is the obvious question. Lately many prominent money managers have come out with serious concerns about the short-term outlook for China. We do not believe this is the telltale of an imminent crisis in China. Higher volatility in a still under-developed capital market is not rare. But, as we have written many times before here and in investor letters, we believe China is converging faster than expected to more normal rates of growth. We cannot claim to be experts on China, but it is clear to us that growth will continue to come down. Whether it will move year after year 7, 6, 5%; or it stays at 7% for 3 years, then 6%, we cannot say. But it seems clear that with reform and development, the effectiveness of central planning is diminishing, which means each stimulus effort will have less of an effect on growth. Convergence towards lower more normal growth is the natural trend. China is obviously too big to underestimate, and it will always require deeper analysis. We remain concerned and focused on understanding these phenomena better, but at this point in time it does not seem that the sharp equity selloff signals a broader crisis with global ramifications is about to happen. What is important to keep in mind is that China’s deceleration is an important driver globally, as it means that sectors and countries that depended on China should adapt to lower and lower rates of growth.

The two more important and fundamental questions, which Greece and China distracted us from, are the first Fed hike (and the monetary policy normalization process) and the global business cycle. These are more important and difficult debates, which is why markets now seem confused and expectant.

The Fed is clearly about to embark in monetary policy normalization, which given how large and unprecedented the stimulus has been, it will be a very long and gradual process. We believe the first hike will happen in September, and a very smooth path, which should not produce drastic changes in valuation formulas, will follow it. However, markets are not that mature about it, and expectations are not coordinated enough. In other words, most investors believe there would be outflows and potentially dislocations in fixed income markets around the first hike, as it signals the beginning of the withdrawal of massive liquidity. The ‘taper tantrum’ of May-July 2013 is still too fresh in people’s minds.

Because we are concerned about the market reaction to the Fed hiking (not only at the time of the event, but before), our portfolios have a lower fixed income allocation than usual, and its duration is around or below 2 years. Moreover, for almost a year our currency diversification has been reduced drastically, with an extremely high concentration in the US dollar, as we believe in its secular appreciation as a result of divergent monetary policies in G3.

The business cycle is a tricky question at this time, as data had started to improve after a very poor first quarter. However, more recent data shows that the only two relatively bright spots in terms of growth are the US and parts of Europe. More importantly, the underlying driver of growth is weak globally, as productivity growth across countries is below what would be expected at this stage in the cycle. Lower capital expenditure explains part of it. There are many theories that try to explain this global phenomenon, some based on the scars from the 2008 crisis, others based on measurement problems. We believe this is a crucial fundamental problem. Without a recovery in productivity growth, there is only so much the US and Europe can recover, and the medium-term valuation of almost any risk asset class would be suspect.

The attempt to explain low productivity growth as a measurement problem is particularly interesting as it is based on the impact of innovation and technology on how GDP should be measured. We cannot deny the argument is persuasive, but cannot help to think that if there were a problem with how GDP is measured in the digital economy, the real productivity growth would show in wage growth and in lower unemployment globally. Another interesting argument is the misallocation of resources due to low rates, as credit is allocated more by new regulations and policies than price. There are many policy-based theories.

The productivity growth debate is crucial and it requires thoughtful monitoring and analysis, though the high frequency data and the Fed remain more important in the short-term. Our equity allocation, close to benchmark, shows that in the short-term we continue to believe in the cyclical recovery in the US and Europe. The composition is defensive on rates and biased to the regions/countries with better fundamentals. Differentiation is key in the next 6-12 months.