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Recent economic developments have hammered equity ETFs around the world, as investors brace for the possibility of a double dip recession at the worst and lingering uncertainty over Europe at the best. One area hit especially hard has been China, which is trying to cool off its overheating economy by hiking rates and curtailing lending. While this is likely good news for the Chinese economy in the long-run, the short term ramifications have rippled throughout the global economy. Copper prices have suffered from expectations of sliding demand, while equities in Taiwan, which finds itself growing increasingly dependent on trade for China to fuel its export growth, were impacted as well.

Despite disappointing news out of the larger global economy, several promising developments have come out of Taiwan recently on the political front. The most important was a trade deal with mainland China that saw duties cut on a variety of goods frequently traded between the two economies. Some believe that this deal could create more than 250,000 jobs in Taiwan and help to boost GDP growth by 1.7% a year in the country. In addition to this historic deal, more data has been piling up in favor of an increasingly robust Taiwanese economy. These new developments have helped to boost the island’s stock market sharply in Tuesday trading–sending the iShares MSCI Taiwan Index Fund (EWT) up by close to 4% in afternoon trading–and could continue to provide economic benefits for months to come. Below, we profile some of the main drivers of EWT’s recent surge.

Free Trade Deals and Exports

Following on the heels of the historic trade deal, it appears likely that China will allow Taiwan to sign free trade agreements with major trading partners via the WTO. According to the report, “China, which claims the self-ruled island as its own and seeks to stop it from doing any official business with foreign governments, had previously used its diplomatic clout to block FTAs that would lift Taiwan’s export-led economy.” This news could be extremely bullish for the Taiwanese economy, as it would permit a diversification of the export base by signing Free Trade Agreements with established economies in Japan and South Korea, as well as quickly growing nations in Southeast Asia.

Taiwanese exports have already been growing at a robust pace and free trade would likely increase this trend. In fact, “exports likely expanded 46.20% in June from the same month last year to US$24.77 billion, their eighth consecutive monthly rise, according to the median forecast of 13 economists.” This has propelled the economy to grow at an annual rate of 13.3% in the first quarter, the highest level in more than three decades, suggesting that the demand for Taiwanese goods is strong even in this uncertain economic environment.

Chip Sales/Cell Phones Boost Earnings

Taiwan is an export-driven economy that has a heavy focus on the tech sector. As such, recent news regarding computer chip sales was seen as a very bullish development for the overall economy. Global chip sales rose 4.5% in May from the prior month, as sales totaled $24.7 billion, up 48% from a year earlier. “Emerging markets, including China and India, are fueling sales of computation and communications products,” SIA President George Scalise said Tuesday. This news has helped to boost chip manufacturers in the country including Powerchip, which returned to profit this quarter after PC sales and chip prices rebounded. The company lost over T$11.7 billion in the same period a year earlier, but posted profits of T$6.77 billion this quarter, sharply ahead of analyst expectations of profits of T$2.51, an increase which further underscores the turnaround for this important sector.

Even more important was the strong sales report out of HTC, one of the largest cell phone makers in the world. The company reported a profit increase of 33% on strong revenues, which were up 58% from a year earlier thanks to a variety of new smartphones which were released earlier this year. “We expect the strong momentum to continue in the second half of the year as HTC will launch another round of new smartphone models in the third quarter,” said Yuanta Securities analyst Bonnie Chang, who expects HTC’s handset shipments to rise to 20 million units this year, up sharply from 12 million in 2009.

Taiwan ETF In Focus

Unlike most country specific ETFs, EWT has a heavy focus on the hardware sector, which makes up more than 40% of total assets. The next largest sectors are consumer goods (24%) and financials (13%) while media, utilities, and health care receive minimal allocation in EWT’s portfolio. The fund has a heavy focus on large and giant cap securities, but allocates 20% or so to mid cap firms as well.

Top holdings include a 14% weighting in Taiwan Semiconductor (TSM), 9.4% in electronics manufacturer Hon Hai Precision (HNHAF.PK), and a 4.6% allocation to another semiconductor company, Mediatek. Despite today’s surge, the fund is down more than 8% year to date, and looks to rebound as the third quarter gets underway.

Disclosure: No positions at time of writing.

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Source: iShares Taiwan ETF Surges Higher on Trade Rumors, Robust Earnings