Although the U.S. economic recovery appears to be gaining steam, lofty stock prices and rising geopolitical risks are finally taking a toll. Last week, stocks suffered their worst one-day slide in six months while volatility reached the highest level since last spring.

However, as I write my latest weekly investment commentary, investors need to look outside the United States for opportunities. In particular, Asian stocks — both developed and emerging — are intriguing, and have outperformed thanks in part to less challenged valuations.

Ironically, the sell-off occurred in a week that brought the release of a string of positive economic news, not the least of which was a strong gross domestic product report for the second quarter. The July employment data also showed more than 200,000 net new jobs were added for the sixth straight month, further confirming that the United States has fully recovered from the first quarter’s economic contraction.

However, the good news was not enough to keep stocks moving higher. Instead, a host of issues caused stocks to sink more than they have in almost six months: Argentina defaulted on its debt for the second time since 2001, a key Portuguese bank was ordered to raise capital, the U.S. and Europe imposed new sanctions on Russia and investors were disappointed over soft earnings from Samsung, Adidas AG and Lufthansa.

The Argentina and Russia situations are suggestive of problems in emerging markets (EMs), although Argentina is technically a frontier market. Nevertheless, last week also saw the largest flows into EM funds since early 2013.

However, much of the turn in sentiment and performance can be attributed to visible improvement in the Chinese economy. Last week, a key measure of Chinese manufacturing activity — the Purchasing Managers Index — improved for a fifth consecutive month. Stronger economic numbers such as this helped Chinese equities to rise more than 8% last month.

And the gains were not limited to China. Korean and Japanese stocks — indirect beneficiaries of the upturn in China’s economy — are also outperforming the broader market.

It is difficult to predict if the spike in U.S. volatility we saw last week will be short-lived. Even if it is, we find still cheap valuations, some lift in China’s economy and improving sentiment are all good reasons to consider larger allocations to Asian equities, including those in both China and Japan.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets or in concentrations of single countries.


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