Why US can rally while Shanghai stocks get smoked

The plunge in hot Chinese stocks is likely to be temporary, and unlikely to spill into world markets unless it becomes prolonged and triggers a recession in the world's second-biggest economy.

For now, analysts see developed markets, like the U.S., Europe and Japan, kicking higher despite the turbulence Thursday that shaved 6.5 percent off the benchmark and 6.2 percent from the Shenzhen component index.

"Traders will enjoy this sort of a move. We've seen this many times in the last several months, where you have a 3, 4, 5 percent down day and then everyone goes back to buying," said Paul Christopher, head of international strategy at Wells Fargo Investment Institute.

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Christopher said other markets are less susceptible to the pullbacks in Shanghai, in part due to the high level of stimulus being provided by global central banks.

He said it would take specific conditions for the Shanghai market to spill into the developed markets. "There would have to be some event, like an end to policy stimulus, a sudden deceleration in housing prices" he said. "Or some large new bankruptcy or string of defaults in China. If you had a large enough decline in China that people were worried about the Chinese economy going into recession, it could have an effect."

He said any of those reasons or defaults by Chinese state-owned entities would be a concern. "If the selloff were 10 to 15 percent on that account, then you'd have to worry about a new deflationary shock coming from China and rippling around the world. I don't think it's a high probability, especially where the Chinese government seems to be more proactive about providing targeted stimulus to areas that need shoring up," he said.

According to news wire reports, there were several factors blamed for the selloff, including a pull back in margin lending by brokerages and profit-taking ahead of a gusher of initial public offerings next week. There were also reports that the People's Bank of China sold repurchase agreements, draining tens of billions in yuan from the financial system recently.

"This market has been doing this for months. The market has been pushed up on speculation about Chinese stimulus in any combination you like—monetary or fiscal, since about August of last year," Christopher said. "Periodically a regulator will come out or the central bank or banks themselves and do something that affects the cost of margin ... the moves by regulators come unexpectedly and always seem to coincide with large moves lower in stock prices."

Read MoreChina stocks lose 6.5 percent, worst selloff in four months

Shanghai stocks are up more than 40 percent this year, with much of the run in recent weeks.

"It outperformed the S&P 500 by about 60 percent from March 10 to yesterday. ... The index is still double from the end of 2012. We had a similar kind of correction in late April into early May," said Robert Sinche, global strategist at Amherst Pierpont Securities. "It shot down and shot right back up again to new highs. When you look at it in this context, the S&P looks like a boring little trend line."

Sinche said it seems the market's downdraft had a lot to do with how overbought Shanghai stocks had become. "The repo operation seemed to be pretty standard although I couldn't think it was any kind of signal that would have created corrections. But I think in general, I think the IPOs, I think we've seen this before where the market gets very extended then you hear a lot of IPOs coming in and lot of people try to get to the exit at the same time."

Citigroup's chief U.S. equity strategist, Tobias Levkovich, said just before and after the financial crisis, the Chinese market was heavily correlated to the U.S. market but no more. Levkovich said there are examples of big selloffs in China, where the U.S. market did not teeter.

"It will affect commodity prices for example. If their economy is not growing, U.S. commodities prices would be affected. But that's not going to take the entire U.S. economy or market down," he said.

As for the U.S. market, Levkovich expects it to continue moving ahead to 2,200 on the S&P 500 by year-end. "I feel OK about it, but it's not good or bad. I have 2,200 for year-end, 2,300 by middle of next year. I think earnings are a critical factor and hopefully earnings will be better," he said.

Even with worries hanging over the market, like higher interest rates or the stronger dollar, Levkovich still expects U.S. equities to move higher. He projects earnings to start to grow faster—at about 8 percent in the second half of the year.

"I think the multiple is not cheap. It's not expensive," Levkovich said. He also does not see the first couple of Fed rate hikes hampering stocks, adding that it's usually about the third rate increase that becomes a negative factor.

Christopher also sees U.S. stocks reaching 2,200 on the S&P 500 by year-end. The S&P was down about 3 points at 2,120 Thursday afternoon.

Even when Chinese stocks rally on good news, "there's no real spillover from policy announcements. ... Everybody knows the policy announcements are coming to counterbalance negative economic news," he said.

Christopher has not been recommending China because of the volatility.

"For investors who are sensitive to losses and volatility, I think there are better ways to play China than putting chips there directly. I would prefer a broadly diversified approach that keeps China small and capped." He said emerging market funds and ETFs are suggested for those investors.

"But for a trader, those people will have a field day," he said.

Traders said another negative factor surrounding Shanghai stocks was the mysterious plunge and subsequent investigation into a solar company owned by Chinese billionaire Li Hegun. The investigation by Hong Kong regulators into Hanergy Thin Film Power was reported Thursday. Li denied knowledge of the investigation, according to wire reports.

The company is a unit of Hanergy Holding Group of Beijing. Its stock was frozen after the drop.

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