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By Sean Geary

The Shanghai Composite (NYSEARCA:FXI) jumped 3% over a two-day span in the middle of this week after dropping substantially on Monday on the back of bad news out of Europe. While the Shanghai Composite, along with other global exchanges, struggled earlier in the week, the Chinese exchange staged a rally on Wednesday after the more onerous terms of the Cyprus bailout on retail investors were modified. In addition, a positive reading from HSBC on the Chinese manufacturing sector boosted sentiment among traders.

Although the previous month's HSBC Manufacturing PMI disappointed investors, as we pointed out these numbers were not necessarily indicative of the health of the Chinese economy going forward, given that February's reading occurred during the Chinese New Year holiday -- a weak period for manufacturing. With the HSBC Flash PMI coming in at 51.7 -- a reading above 50 indicates sequential growth -- well above analysts' estimates of 50.8, some pessimism surrounding the Chinese economy could dissipate.

The negative perspective toward the Chinese economy has festered over the past month, resulting in a 10% drop in the Shanghai Composite. Despite the two-day rally in China's benchmark index, this downtrend remains intact. However, more good news pertaining to the Chinese economy could see the Shanghai Composite resume its rally that lasted from December to February.

Tom DeMark of Market Studies LLC espouses this point of view; he correctly predicted the short-term top in the Shanghai Composite in February, and he now sees the market surging 48% from its December lows by September. If the Chinese economy receives more positive news, inflationary pressures remain in check, and developers see minimal effect on sales after this month's new property curbs, the Shanghai Composite could be poised for a breakout. However, if the extant downtrend remains intact, traders should continue to play the Shanghai Composite on the short side.

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Source: Shanghai Composite Stages 2-Day Mini-Rally