Shanghai’s A-Share market has been trading in a sideways pattern since making a major high five months ago. Hong Kong is also currently trading in a sideways pattern.

Taipei’s market, on the other hand, has been making higher highs and higher lows — a classic up trend. As a result, Taiwan is also the only one of Greater China’s three main bourses to have made a new 52-week high in 2010, following a 78% gain in 2009. And the Taiwanese stock market is currently the strongest from a technical perspective.

And there are three main reasons why Taiwanese stocks will continue to be a good bet this year.

Reason #1 – An increase in mainland Chinese investment

While China would still like to see Taiwan become part of the country, Beijing’s leaders figured out that it is easier to buy Taiwanese assets than to fight for them. So, last year, state-owned wireless giant China Mobile (CHL) announced a deal to invest in a major Taiwanese telecom company, spearheading a new trend of direct investments from Chinese state-owned enterprises (SOEs).

And this year, qualified mainland Chinese institutional investors and mutual funds will be allowed to invest in Taiwanese stocks. Chinese institutional investors control one of the largest pools of liquidity in the world today, and if Chinese government sends a mandate to buy Taiwanese assets, tens of billions of dollars in investments will enter Taiwan quickly.

Reason #2 – A reduction in the estate tax

In the past, to avoid the island’s confiscatory estate tax, many wealthy Taiwanese parked significant assets offshore. As a result, Taiwanese invested more than $200 billion in mainland China during the past 30 years. To lure offshore funds back to Taiwan, Taiwan’s maximum estate tax rate was lowered from 50% to 10% last year. Tens of billions of dollars flooded back to Taiwan in the past year, a large chunk of which was parked in Taiwanese stocks and Taipei real estate.

Reason #3 – Strong earnings growth

Although Taiwan’s economic growth rate is projected at 4.4% in 2010, the island’s largest companies are expected to grow their earnings by an eye-popping 56% as the global recovery, Chinese monetary stimulus and influx of capital will all help Taiwanese companies thrive.

These strong positive fundamentals will support another strong year for Taiwanese stocks. The best way to profit from Taiwan’s continuing economic recovery and the strength of its stock market is to invest in iShares MSCI Taiwan Index (EWT).

This exchange traded fund (ETF) allows us to play the whole Taiwanese market at once, as it tracks the island’s Taiex index. EWT shares were up 70% in 2009. And given my expectations for Taiwanese shares to show strength in 2010, I’m lifting our buy limit for EWT to $13.50.

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