The latest drop came after the Hang Seng Index hit an intraday peak of 31,958.41 on Tuesday. The blue-chip index opened 912.81 points lower and fell as much 1,126.19 before recovering some ground to close down 1,024.54 points at 30,468.34.

The H-share index fell 624.09 points or 3.1 per cent to 19,540.13.

Property stocks were among the biggest losers, as investors took profit following the interest rate cut announced on Thursday. Cheung Kong (Holdings) fell 5.57 while Sun Hung Kai Properties dropped 4.66 per cent.

As the Hang Seng Index had surged more than 4,000 points last month, analysts have turned bearish and believe the market is likely to see a marked correction this month.

Jim Walker, the chief economist at CLSA, said the market would fall 10 per cent in the next 12 months.

'Bubbles have appeared in Hong Kong's stock market but people seem not to have realised that yet ... [the bubbles are] due to the fact that large amounts of capital continue to flow into Hong Kong,' Mr Walker said. 'It will become more apparent in the next three to six months and Hong Kong shares as a whole will correct by about 10 per cent in 12 months.

'The Hang Seng Index is expected to correct by 3,000 to 4,000 points soon ... the floor of the index should be around 25,000.'

Other Asian markets were weak yesterday following the US slump, with most of them slipping more than 1 per cent. Shanghai closed 2.31 per cent lower at 5,777.809 points.

Wall Street stocks fell further yesterday, with the Dow Jones Industrial Average down 0.47 per cent at midday. Merrill Lynch led the slide in the financial sector, dropping as much as 11.35 per cent.

European markets were also weak. London's FTSE 100 Index was 1.33 per cent lower in late afternoon.

'Yesterday's tumble was more a healthy correction than a cause to panic,' said Patrick Yiu Ho-yin, an associate director at CASH Asset Management. 'The Hang Seng Index and H-share index have surged 15 per cent and 18 per cent in October alone. It's time for consolidation before heading for 40,000 points.'

According to Andrew Luk, a strategist at investment bank UBS, the market is significantly ahead of its fundamentals as some investors appear to be pinning their hopes on liquidity from the mainland.

'We expect the market to correct by one-third of its recent rally - a 3,000 to 4,000-point downside - after the index has risen from 20,000 points two months ago to a recent peak of near 32,000,' Mr Luk said.

The bank reiterated its view of the Hong Kong market hitting 28,000 by the end of next year.

The recent market rally is mainly due to liquidity inflows from the mainland while the relatively expensive valuation is also supported by strong earnings from Hong Kong corporates and mainland enterprises.

The Hong Kong market is now trading at 21 times earnings this year, lagging behind the 50 times for the mainland market.

Warning signs

Analysts believe the market is likely to see a correction this month

The price-earnings multiple of the Hong Kong market is 21 while that of the mainland market is 50