SHANGHAI (AFP) - Fasten your seat belts investors: China's volatile stocks still have room to drop, but analysts say keeping the rollercoaster on the tracks will depend on how the government manages its eventual exit from the market.
An 8.48 per cent plunge on Monday - the biggest in eight years - renewed fears about the government's management and the health of the underlying economy, in which growth has already slowed to levels unseen since the global financial crisis.
In moves widely criticised as anti-market, the government has intervened by barring some investors from selling, setting up a war chest to buy stocks and threatening to arrest those who engage in short-selling - a bet prices will go lower.
But after an exuberant, government-engineered 150 per cent rise over the 12 months to mid-June when the market peaked, and a 29 per cent correction between then and Tuesday, analysts said prices can go still lower.
"A big rebound seems unlikely now," Zhang Gang, an analyst from Central China Securities, told AFP. He expects the Shanghai market to test support at 3,500 points and then at 3,200.
The benchmark Shanghai Composite Index was down 0.21 per cent at 3,655.27 by the break Wednesday.
"The (government) measures are generally on the right path, but it takes time for the market to recognise it," Zhang said. "After the risk is resolved, the market will perform better next year."
The key will be how the government manages divestment of its newly acquired stock holdings without spooking tens of millions of "mom and pop" investors, the main force in China's markets who trade on rumour and speculation.
Worries the government is preparing to exit the market, despite repeated denials including the latest on Monday, was the trigger for the biggest fall since February 2007.
"I do think they will reduce intervention which is what the market is afraid of these days," Steve Yang, a strategist at UBS Group in Shanghai, told Bloomberg News.
"The process will be very long. They do not need to rush to sell their positions in the short term."
Other negative factors are out of the control of securities regulators: an expected US interest rate hike affecting global activity and China's own slowing growth - the economy expanded 7.0 per cent in the second quarter, a far cry from double-digit increases of the past.
But exactly where the bottom might be, nobody knows.
Gu Luxian, a former bank employee who trades stocks full-time after leaving his job, plans to return to the market after it falls at least another 20 per cent.
"I'll wait until the market slumps to 2,800 points to buy stocks again. Everybody is leaving the market, so why stay?" he told AFP.
But Japan's Nomura believes the plunge represents a buying opportunity and urges its clients to selectively pick up stocks.
"Market consolidation may continue until the interim results season in mid-August upon more positive micro-level and macro-level data," Nomura said in a research report.
"We suggest investors take advantage of this likely second bottom to buy stocks with structurally sound fundamentals." Regardless, volatile trading will reign and could impact the world's second largest economy as a slowdown in financial activity cuts into growth.
"The stock market will continue to be very volatile despite the high-profile rescue package," ANZ Banking Group said in a research report. "The stock market volatility does present some downside risks to China's growth outlook.
US analyst Tom DeMark, founder of DeMARK Analytics, told Bloomberg News that behaviour in the Chinese stock market mirrored the 1929 Wall Street Crash, which helped trigger America's economic "Great Depression".
He expects the Chinese market to fall to 3,200 in the next three weeks and says government measures to stem the slide are futile.
"You just cannot manipulate the market. Fundamentals dictate markets," he said.