April 28 (Bloomberg) -- Taiwan’s improving China ties are spurring optimism the island will profit from increased trade, leading Goldman Sachs Group Inc. to upgrade its growth forecast and JPMorgan Chase & Co. to raise the Taiex index’s target.

Goldman Sachs boosted its 2010 growth forecast to 3.5 percent from 2.5 percent, economist Enoch Fung wrote in a note. The Taiex may rise 40 percent to 8,000 from yesterday through the end of the year, according to JPMorgan analysts including Nick Lai. The Taiwan dollar will advance 5.5 percent to NT$32 in the same period, said David Cohen, director of Asian forecasting at Action Economics in Singapore.

The island’s stocks are the world’s seventh-best performer this year, while its currency has strengthened from a seven-year low reached on March 3 as the two parties hold cross-strait talks. Relations have improved since Taiwan President Ma Ying- jeou won elections in March last year, abandoning his predecessor’s pro-independence stance.

“Development on key cross-straits issues, such as direct flight and shipping, Chinese tourism, relaxation on Chinese investments in Taiwan and financial MOU, will play a critical role for Taiwan’s long-term structural growth, in our view,” the JPMorgan analysts wrote.

Taiwan is seeking to bolster ties with China amid a slowdown in the island’s $355 billion economy. The island’s GDP may contract 2.97 percent this year, the government forecast in April, reversing its November estimate of 2.12 percent growth.

The island has enjoyed self-rule since Chiang Kai-shek’s Nationalists fled the mainland in 1949 after losing to Mao Zedong’s Communists in a civil war.

Bearing Fruit

In addition to its 2010 forecast, Goldman Sachs also said Taiwan’s economy will shrink less than earlier expected this year. Gross domestic product may fall 7 percent this year, less than an earlier prediction of a 7.5 percent contraction, the brokerage said.

“The cross-strait policies implemented so far are now gradually coming to fruition, positioning Taiwan to better leverage the growth recovery in China,” Hong Kong-based Fung wrote in the note.

China and Taiwan will set up a supervisory mechanism enabling their financial services companies to operate in each other’s markets, according to an accord signed over the weekend following talks in the eastern Chinese city of Nanjing. They also agreed to more than double weekly direct flights to 270 from 108. Both parties are expected to meet for a fourth time later this year.

‘Overweight’ Technology

In Taiwan, investors should be “neutral” in financials and “overweight” in technology, JPMorgan said. The brokerage raised its rating on shares of Taiwanese banks, brokers and insurers to “overweight” from “neutral” in its regional financials portfolio, citing the prospects for ties with China.

It upgraded Yuanta Financial Holding Co., Sinopac Financial Holdings Co., and Chinatrust Financial Holdings Co. to “overweight” from “neutral,” and raised its recommendation on First Financial Holding Co. and Chang Hwa Commercial Bank to “neutral” from “underweight,” according to a separate report by the brokerage.

The Taiwanese stock benchmark fell 1.9 percent today, extending yesterday’s 3 percent slump. It has gained 22 percent this year, outpacing 83 of the 90 global indexes tracked by Bloomberg and the MSCI Emerging Markets Index, which has climbed 9.3 percent.

Gains this year have made the market more expensive. The Taiex is valued at 28 times reported earnings, higher than its five-year average of 16 times. That’s as earnings decline by about 70 percent this year, after a 60 percent slump in 2008, JPMorgan estimated.

‘Signs of Stabilization’

Still, profit growth next year will be “significantly higher” than in 2009, helping drive gains in the island’s stock market, the brokerage said.

Emerging-market fund managers are also “underweight” on Taiwan by about 2.7 percentage points, JPMorgan said. A change in that view to “neutral” will draw about $3.1 billion of funds into the stock market, the brokerage added.

“Data points over the past month show early signs of stabilization,” the JPMorgan analysts wrote. “We recommend that investors take positions on any major pull-back.”

The Taiwan dollar fell 0.2 percent to NT$33.795 as of the 4 p.m. close, according to Taipei Forex Inc. The currency weakened to N$35.297 on March 3, the lowest since July 2001, and has lost 9.9 percent against the U.S. dollar in the past 12 months.

“Continued positive relations with Beijing will be supportive for the Taiwan dollar,” Action Economics’ Cohen said.

To contact the reporter on this story: Chen Shiyin in Singapore at schen37@bloomberg.net; Bob Chen in Hong Kong at bchen45@bloomberg.net

Last Updated: April 28, 2009 06:09 EDT