Emerging market equities had a great run in January, with the MSCI Emerging Markets Index gaining 11.2 percent. This performance dovetails with our commentary from mid-December:

“Investors are pessimistic and there’s not much in the way of excitement when it comes to the stock market. Although such anxiety is understandable and justified, it sets the stage for contrarian calls. In other words, if the majority of investors expect a negative outcome, the markets may surprise by posting strong gains.”

The markets have obliged thus far, as a gradual improvement in economic data in the developed world has persuaded investors to assume greater risk. Emerging markets have attracted investor attention due to their relatively cheap valuations and pro-growth economic policies. Consequently, emerging market equity funds enjoyed inflows of more than USD8 billion during January, with roughly USD6 billion allocated to Asia ex-Japan funds.

Investors’ “risk-on” attitude is best evidenced by the fact that last year’s hardest-hit emerging market stocks have been leading the rally higher. The energy, materials, and financials sectors have recorded double-digit gains, while more defensive sectors such as telecoms, consumer staples, and utilities have been relative laggards, with returns averaging in the mid-single digits.

Asia, which remains a focus of mine because of its structural strength and potential for long-term growth, is rightfully receiving the lion’s share of investors’ funds. The reason is twofold.

First, valuations remain relatively low after Asia’s massive underperformance last year.

Last October, I noted the following: “The current valuations found in Asia offer long-term investors an attractive entry point… Asia as a whole trades at about 1.5 times book value, a compelling valuation so long as a new global financial crisis fails to materialize. By comparison, Asia traded at 0.9 times book value in 1998 after the Asian Financial Crisis, and at 1.3 times book value amid the 2008 global financial crisis.”

Second, Asia offers the best long-term economic fundamentals of all the emerging economies. That makes Asian stocks attractive to individual investors and institutional money managers alike.

Additionally, Asia’s economic growth is resuming its upward trend. The Purchasing Managers Indexes (PMI) for both China and India recently produced readings above 50, a level which indicates economic expansion. Meanwhile, the PMIs for both Taiwan and South Korea are approaching that key threshold after rebounding from last quarter’s lows. Asia’s economic recovery is still unfolding, but indicators suggest economic growth is regaining momentum.  

Although stocks are well off last year’s lows, they still have further room to rise before they could be considered overvalued. Of course, the global economy still faces formidable challenges, so investors should not expect an uninterrupted ascent. Even so, investors should take advantage of any periods of weakness to add to their positions.

But that doesn’t mean that investors should blindly pursue risk. Instead, concentrate on paring defensive positions and hedges in favor of equities. Focus on Asian stocks, like the ones in my free report, as well as the banking, energy, real estate, and industrials sectors. Two top picks of mine are KB Financial Group (NYSE: KB) and Banco Bradesco (NYSE: BBD).