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China market bounce: trend change or false alarm?

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The recent rebound in China's equities has generated some optimism that the country's beleaguered stock market may be set for a turnaround.

The benchmark Shanghai Composite Index is up 4 percent in the past week and hovering at three-week highs, spurred by positive economic data.

The government's twin Purchasing Managers' Index (PMI) reports for the manufacturing and non-manufacturing sectors for July both came in better than expected, raising hopes that the slowing economy may be getting some of its growth mojo back.

Chinese stocks have been steadily climbing over the last couple of weeks, after the government unveiled a "mini stimulus" package in late July to boost business investment, leading many analysts to predict that more growth measures are on the way.

Still, China watchers are tempering the cheer, cautioning that the gains may be more of a knee-jerk reaction, rather than a pivot point for the markets.

"For now, it's still just a short-term rebound in a bear market. The stronger performance is due to policies to stimulate the economy and recent PMI data, which show China's economy is stabilizing," Jackson Wong, vice president at financial services firm Tanrich Securities told CNBC.

(Read more: China fires growth salvo, is monetary easing next?)

In order for the market to sustainably reverse its longer-term downtrend, domestic investor sentiment would need to recover substantially, Wong said, noting that this shift may happen if China delivers a sustained improvement in economic data over a period of a few months.

"Domestic investors don't trust the stock market at all. With stocks in bear market, every time they buy, they lose," he said.

"If the economy shows an improvement in growth that will attract foreign investors and institutional investors in China, which will help change the sentiment," he added.

The benchmark Shanghai Composite is down 9 percent since the start of 2013, weighed down by concerns over a growth deceleration and tighter liquidity conditions in the world's second largest economy.

A break above the index's next resistance level of 2,100 would be a positive signal, he added. The index traded at around 2,052 on Wednesday.

The slew of upcoming economic data this week will be important in determining the market's next moves, in particular the consumer price inflation (CPI) and producer price inflation (PPI), he said. Producer prices in China have been declining since February 2012, weighed down by falling commodity prices, overcapacity and weakening demand.

(Read more: China Remains Entrenched in Producer Price Deflation)

After a disappointing first-half, Wong expects China's economy to strengthen towards the end of the year and into 2014. As a result, Wong says he is sticking to his target for the Shanghai Composite of 2500 by year-end, representing a 22 percent upside from the current levels.

"It will depend on the pace of improved data out of China, and economic reforms. But there is no huge downside risk from here," he said.

—By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H

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