Pointing the way to the next two stars of Asia

Come springtime, however, the net effect of negative sentiment made several markets look more attractive. Cheaper valuations and more positive fundamentals led many investors to look at emerging markets again, with Chinese stocks in particular coming close to reaching new highs by the end of the summer.

As we approach winter in the UK, the investment climate has changed once more. Emerging market equities had a tough September, with a number of factors likely to be sources of volatility in the fourth quarter.

Chinese data is one of these factors. China’s official growth target stands at roughly 7.5 per cent for 2014, and while it is likely that this will be achieved, the growth path has become more uncertain, with questions raised about next year’s target.

Political change in Brazil is also a source of market uncertainty. In the run-up to the presidential election, hopes for a reform-minded election result drove Brazilian equities, but fundamentals have continued to worsen.

There are still plenty of good investment reasons to allocate to emerging markets but, against this backdrop, a differentiated country and regional approach is most likely to capture the next phase of growth.

Emerging Asia currently looks attractive compared to regional peers.

At a country level, there are several bright spots that investors can tactically tilt their portfolios towards, using instruments such as exchange-traded funds (ETFs).

The outlook for Korean stocks is potentially more positive due to support from its central bank and recent reform announcements. In August, the Bank of Korea cut interest rates by 25 basis points (bps) to 2.5 per cent.

Although the bank’s governor did not signal the need for further easing, another rate cut this year is not off the table should growth weaken further.

Meanwhile, changes are afoot in corporate dividend policies. Korean companies have historically had low dividend payout ratios, but a change in government policy is pending that is expected to start to change this culture. The legislation has yet to come before parliament – but if it passes, it may mean that companies need to raise dividends significantly to meet the eligibility for tax cuts.

These two factors have boosted the momentum of Korean equities, and with the 2014 consensus earnings growth for Korean companies now standing at 13.1 per cent – stronger than emerging Asia’s 10.2 per cent and emerging markets’ 7.4 per cent – we are positive on the country.

Another example of a market worth watching is Taiwan. Taiwanese equities have delivered 8 per cent year to date, whereas emerging market stocks have been flat.

More than 50 per cent of Taiwanese stocks are in the tech sector and have strong linkages with the US, which means that the equity market is highly geared to the US recovery.

Taiwanese stocks also have a high dividend yield, making this market an ideal play in terms of the ongoing investor search for yield.

Investing in emerging markets does not come without risks, and challenges lie ahead as the end of the year approaches. Geopolitical risk is in a heightened state and developed market central bank announcements could spark more volatility. Differentiating between countries and regions may help to capture the areas of upside that are still within the broader emerging market universe.

Stephen Cohen is chief investment strategist for BlackRock International Fixed Income and iShares EMEA

Key figures

7.5%

China’s growth target for 2014

25bps

The Bank of Korea cut interest rates by 25 basis points to 2.5 per cent

13.1%

The consensus earnings growth for Korean companies in 2014, compared to 7.4 per cent for emerging markets