“Islamic State recognizes Taiwan in new propaganda video"

James Syme, Senior Fond Manager at JO Hambro overweighted Taiwan since 2013, and is still convinced of Taiwan – but with the words "Nothing lasts forever".

Followers of our views will be aware that East Asian geopolitics is one of the emerging markets risks that we worry about most. The complicated list of actors includes China, North Korea, South Korea, Taiwan, Japan and the United States. Despite the above quote, we do not expect Islamic State to become a significant player in East Asia. Rather, we highlight the quote as it
shows just how delicate the relationship between China and Taiwan is. As the largest and third-largest markets in the MSCI Emerging Markets Index respectively (with a combined 38.3% weight as at 1 December), this relationship matters to emerging markets investors.

Given that, the meeting in November between Chinese president Xi Jinping and the Taiwanese 'leader' (as Western media prefer) Ma Ying-jeou was an intriguing one. Various views have been advanced for the meeting, but we feel that it was probably a warning from China to Taiwanese voters to focus on domestic matters rather than a move toward independence in 2016. That message would have been sent because Ma’s governing nationalist Kuomintang Party (KMT) is almost certain to lose to the pro-independence Democratic Progressive Party (DPP) in the January 2016 presidential election.

"China and Taiwan are 'brothers'"
At the same time, the neutrality of the meeting (apparently the two leaders avoided titles and even split their dinner bill) demonstrates to Taiwan and to the world that China will respect a Taiwanese government that maintains the status quo. Xi referred to China and Taiwan as “one family” and called the countries “brothers". Similarly, ahead of the meeting, the secretary of the DPP, Joseph Wu, stated the DPP's aim to "maintain the status quo".

Ultimately the relationship remains a challenge for Taiwan. China has a massive economy, rapidly growing importance in global multinational bodies and, of course, significant military ambitions. The Taiwanese economy suffers from some structural issues that constrain the longer-term growth outlook, including the continued process of industrial hollowing-out as skilled workers and company operations move to China, and the increasing trade competitiveness from China as its exports move up the value-added chain.

In an emerging markets context, Taiwan is in a good position, with capital inflows still coming from its strong exports (2015 current account balance estimated at 13.9% of GDP), and many Taiwanese companies are attractive precisely because of their large Chinese operations. The market is still reasonably valued at a 12.3x forward P/E ratio and should be a beneficiary of a recovery in US domestic demand. We are positive on both exporters (particularly in technology) and also financials in Taiwan and are overweight the market. At the same time, we are aware of the longer-term challenges and risks for the country. We like Taiwan and have been overweight the market since October 2013, but nothing lasts forever.