The European Union's problems dominated headlines during the second quarter of the year, but it was a tumultuous three months in China's markets— and that country's economic remodeling—that will hold greater implications for the global economy in the long term.

Chinese investors shaved 23% off the Shanghai Composite Index between April and June, a nosedive that put it at a 14-month low and left it in bear-market territory. The Shanghai index of domestically traded "A share" stocks—accessible to domestic investors and a handful of overseas institutions—finished at 2398.37, down nearly 27% so far this year, making it the weakest major market in Asia and one of the weakest in the world.

The Chinese stock market has declined even as the country's gross domestic product and companies' earnings grow by double digits. The slide reflects deeper concerns among Chinese investors about several wild cards, including the effectiveness of Beijing's attempts to cool the housing market; the country's ability to sustain its strong economic growth amid rising labor costs; and the implications of a rising yuan.

Many of those fears came to the forefront in the closing days of the quarter, as investors pushed stocks down more than 7% during a six-day losing streak, driven by concerns that China won't be able to sustain its torrid growth in the second half of the year. Also worrying investors was a weak investor response to the US$23.3 billion Agricultural Bank of China Ltd. initial public offering scheduled for mid-July, which priced at a lower-than-expected range earlier this week.

Francis Cheung, a Hong Kong, China-based stock strategist with CLSA Asia-Pacific Markets, says he expects global investors to increase their exposure to China once it works through its current problems. But Mr. Cheung said that could take time, with downward revisions to GDP and earnings on the way and a continuing property tightening campaign that he believes Beijing is only "midway through."

Bigger Impact

A sustained stock-market decline could have implications beyond China's closed markets, pinching sentiment at a time when much of the world is still looking to China to lead a robust global recovery. How the China story plays out promises to have an impact on commodities like copper that figure large in construction, currencies like the dollar, and global companies that are relying on the rise of the Chinese consumer.

In the near term, some analysts think Chinese investors haven't fully priced in the myriad risks to domestic stock prices. They point to the looming threat of a nationwide property bubble and labor unrest at a number of Chinese manufacturers that some think could signal an end to China's status as the world's factory floor.

Minggao Shen, Citigroup's chief economist for greater China, said that while the country's GDP and corporate numbers in the first half of the year have been surprisingly resilient, the real challenge will be maintaining those numbers as the uncertainties pile on.

"The one word that we're urging is 'caution,' " Mr. Shen said. "The question now that many people have, including us, is not believing this kind of fast growth can be sustained in the second half of the year."

Mr. Shen cites the European debt crisis, the relatively weak U.S. economy and China's own attempts to wean itself off last year's stimulus plan as the biggest risks. He expects export growth to fall to below 20% a year, far below China's historical figures.

As the quarter came to a close, a new theme took center stage: the pace at which China's currency appreciates. Policy makers in mid-June said they would allow the yuan to move beyond its narrow band and trade at a more flexible exchange rate.

Analysts remain divided on how much Beijing will allow the yuan to rise and what that might mean for stocks, though investors pushed the Shanghai stock index up 3% on June 21 after Beijing's announcement. That excitement has since given way to broader concerns about growth, as well as lingering questions about Beijing's commitment to currency flexibility.

Those on the bullish side argue that loosening the yuan's peg to the U.S. dollar will help reduce trade tensions between the U.S and China and lower the specter of protectionist tariffs on Chinese exports, while helping Beijing broaden the monetary-policy options at its disposal. That could give the Chinese government more flexibility to weather future economic challenges.

The rising yuan could also boost Chinese consumers' buying power at a time when investors and governments are searching for signs of rebalancing in the Chinese and global economies.

Others take a more bearish view, arguing that a rising yuan adds more pressure to a Chinese export sector at a time when that core engine of Chinese growth is already struggling with rising wages and a weak global economy.

China's attempts to cool its overheated property markets are another source of stress. If Beijing is successful in cooling off residential prices that have skyrocketed in the past year, it would damp property investment—which directly and indirectly accounts for about one-fourth of China's GDP.

A bursting of the bubble would drain household wealth and hurt the share prices of developers, construction companies, home-appliance makers and car companies. Commodities like copper and oil could also be pinched given their sensitivity to Chinese construction demand and economic growth.

Failing to damp property-price growth, on the other hand, has its risks too. Officials in Beijing are nervous about the growing ranks of Chinese who feel they've been priced out of the market, potential fuel for social instability. Allowing a bubble to further inflate would also set up a larger reckoning down the road.

Wage inflation, a third unknown, is something of a double-edge sword. Higher wages play into a long-hoped-for development in China: spurring domestic consumption in a country that has one of the highest savings rates in the world.

More service-sector spending in China would help the global economy rebalance. On the other hand, wage inflation in the near term squeezes profit margins for the labor-intensive industries that have traditionally powered Chinese growth.

Mr. Shen of Citigroup looks to economies like those of South Korea and Taiwan, China in the mid-1980s. As in China today, annual per capita GDP in those economies was at about $3,000 and growing by about 10% per year when wages began to increase. In both cases, Mr. Shen says those countries' stock markets outperformed those of the U.S. and other Western countries "sizably."

Insiders Bullish

Amid the uncertainty, one group of investors has been bullish: large insider shareholders of Chinese companies, who in May were net buyers of A shares for the first time in nearly two years, according to Mark Matthews, a Hong Kong, China-based equities strategist with Macquarie Securities.

Taken together with what he regards as the positive yuan news, Mr. Matthews says, "I would not want to be short China at this juncture."