There are tentative signs of economic stabilisation in emerging markets and the monetary cycle looks supportive of equities, says Adrian Mowat, managing director and emerging market equity strategist at JP Morgan.

While emerging markets were the last to slip into recession, they will be the first to bounce back as results of pro-growth monetary policies start kicking in, he says.

In a report titled 'The Big Ugly Experiment', Mowat says that Asian companies and economies are in uncharted waters.

"The big ugly experiment is whether aggressive monetary and fiscal stimulus can offset the impact of the deepest consumer recession in developed economies since World War II," says Mowat.

Among sectors in Asia, JP Morgan prefers financials, domestic consumer discretionary and consumer technology. Notwithstanding the fall in the Sensex and the Nifty during the end of 2008, major emerging market fund managers actually increased their allocation to India in December.

Mowat believes that inflation has peaked in emerging markets. However, the main concerns for investors now are capital market volatility and a lack of confidence in growth.

"Our asset allocation favours markets that are ahead in the inflation monetary cycle and provide faster growth," the report says.

The rout in commodity and energy markets has been the catalyst for the significant redemption-led selling. Redemptions began in June for Latin American funds and in July for emerging market funds with cumulative net redemptions of $4.6 billion and $ 3.3 billion. JP Morgan says that this redemption-led selling is generating distressed valuations. Asian funds saw net redemptions worth $9.2 billion since mid-May.

The report recommends that investors go long on Taiwan and short on Korea. The reasons behind this change in stance for Korea are uncertain macro, downside risk to earnings, politics, China's stimulus package's benefit to Taiwan and lower relative cost of funding.

JP Morgan is overweight on China, Mexico, Taiwan, the Philippines, South Africa, Turkey and Thailand.

"The number of managers with overweights in China and Hong Kong increased from 13 to 17, while the number of underweights reduced from 12 to 9. Mexico has the least number of managers with an underweight position. No managers in Korea are overweight in their portfolio," says the report.