The Australian stock market staged an afternoon recovery after opening sharply lower on the back of a freefall on the benchmark China index and resultant weakness in both US and European markets.

The S&P/ASX200 and All Ordinaries Index both dropped around 3.5 per cent in morning trading but had recovered slightly by close of the market.

The benchmark S&P/ASX200 index ended the session down 2.6 per cent, or 157.7 points to 5836.1, while the All Ordinaries Index lost 2.6 per cent or 159.4 points to 5818.2.

Australian investors woke up yesterday to witness what seemed a global stock market retreat, prompted by a 9 per cent drop in the China's benchmark Shanghai Composite Index - its biggest daily percentage fall since 1997.

The US Dow Jones industrial average fell 3.29 per cent on the news - its biggest fall since the September 11 attacks of 2001 - and the UK's benchmark the FTSE 100 fell 2.3 per cent.

The consensus in the market, however, is don't panic.

"I think the correction is a positive. It will enable superfund investors to buy a bit more sanely," investment specialist and founder of Huntley's newsletters Ian Huntley said. "I can't see that a China stock bubble being pricked is the end of the world."

The correction could be what is needed to take the "dangerous parabolic rise" out of the market, he said.

Colonial First State's head of investments Hans Kunnen agreed. He said global markets could be doing a repeat of 2001, where the market had run ahead of itself.

"All I would say is remember May and June last year. Everybody thought it was the end of the world then. When the markets fell by 10 per cent there was a similar wobbling of the knees," Kunnen said.

He added that the fall in China's markets by no means meant the end of the boom. "The economic fundamentals in China have not changed. It was a market that ran ahead of itself last year with rampant growth and needed squashing," Kunnen said.

"China's growth is based on structural change that will last for decades. People are making erroneous linkages."

Despite Alan Greenspan's dire predictions last week that the US could be going into a recession, it was more likely the US economy was slowing down rather than stopping altogether, he said.

"Yes the day traders might have been smashed, but they need a long term perspective. Japan and Europe are growing, yes the US is slowing, but that is not the end of the story. This is a buying opportunity," Kunnen said.