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This Asian market laggard could shine in 2014

After underperforming their regional peers this year, South Korean stocks should rally 18 percent in 2014, according to a recent report from Nomura.

The brokerage sees the benchmark Kospi at 2,350 by the end of 2014, a far cry from its current level of 2,011. For 2013, the index is up a meager 0.7 percent, compared with the Hang Seng Index's 3 percent gain and the Taiex's 12 percent rise.

(Read more: South Korean private equity flourishes)

Employees celebrate the close of trading for the year at the Korea Exchange (KRX) on Monday, Dec. 30, 2013.
SeongJoon Cho | Bloomberg | Getty Images
Employees celebrate the close of trading for the year at the Korea Exchange (KRX) on Monday, Dec. 30, 2013.

While Nomura's targets may seem ambitious, it says that improving exports and solid earnings growth underlie the index's upside potential.

Recent data has painted a tepid picture for the world's seventh-largest exporter. In November, overseas shipments inched up just 0.2 percent from a year earlier, a drastic drop from October's record high. But Nomura's economists say a faster global growth rate next year should see exports rebound.

(Read more: South Korea data equals merry Christmas shopping?)

"Improved demand from the U.S. and the euro zone should support Korea's exports; not only to these two regions but also to emerging markets that import Korean goods for re-export. We continue to believe that Korea is the most leveraged play to a global macro recovery given its high dependency to international trade," the report said.

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Improved margins for Korea Inc. make up the second component of Nomura's bullish outlook. While the brokerage warns that the first half of 2014 could remain volatile as the Federal Reserve begins reducing its monthly asset purchases, they expect 2014 to bring 19 percent annual earnings growth.

"We believe that equities will need earnings growth to support further gains from here — much of the macro risk-compression / "deep value" mean-reversion upside arguments have now played out. Our Kospi 2014 fiscal year-end target of 2,350 implies 18 percent upside. Earnings growth of 19 percent year-on-year will be led by cyclical sectors that have experienced significant earnings drops over the past two years."

(Read more: South Korean stocks enjoy longest foreign buying spree)

"We believe Korea should outperform its regional peers given its high-beta characteristics and valuation discount (though not as highly under-valued as in previous years) relative to its long-term average," they added.

No more yen headwinds?

A declining yen has weighed on profit margins of manufacturers with the Japanese currency down about 18 percent against the won this past year. A lower yen makes Korean goods more expensive by comparison in global markets but Nomura isn't too worried about the future.

(Read more: Yen set for worst year since YMCA topped the charts)

"In our view, the significant depreciation of [the yen] due to Abenomics has largely come to an end. Thus, we are becoming more optimistic on the Korean auto sector, which has been hit the most among Korean sectors by the [yen's] depreciation."

However, not all analysts are quite as bullish on South Korea. The latest note from Barclays indicates the economy could be hit by politics in the near-term.

"The two parties in the National Assembly failed to conclude the passage of the proposed 2014 spending budget by its deadline on Dec. 2, 2013. As a result, there is a possibility the government could face an automatic reduction of its fiscal spending (the so called fiscal cliff) early next year. Concerns about government spending and political headwinds will dampen consumer sentiment and corporate investment as well, in our view," said Chanik Park, head of Korea research, Asia Ex-Japan equity research at Barclays.

By CNBC.com's Nyshka Chandran. Follow her on Twitter @NyshkaCNBC

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