Japan's blue-chip stock index has in May suffered its two sharpest sell-offs for the year and its high volatility is fueling concern about a spill over into other major markets.
The Nikkei stock index tumbled over 5 percent on Thursday to its lowest level in a month, knocked down by a strong yen and a fresh bout of profit taking on this year's double-digit gains.
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Equity markets in Europe and the U.S. shrugged off the Nikkei's slide to close higher, but strategists say they're not so sure how long they will stand up.
"I don't know how much longer the U.S. markets can hold off [Japan volatility] and I was surprised we didn't open lower [Thursday]," said Mike Crofton, CEO at the Philadelphia Trust Company. "The market is obsessed with the Fed [Federal Reserve] and whether or not it will take its foot off the pedal and so we opened higher on the U.S. economic data," he said, offering a reason why markets had been able to withstand the Nikkei tumble.
Data on Thursday showing an unexpected rise in weekly jobless claims and the U.S. economy growing at a 2.4 percent annual rate in the first quarter, slightly short of estimates for a 2.5 percent gain, eased worries that the U.S. Federal Reserve could start taking back its monetary stimulus soon.
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The Nikkei opened more than 2 percent higher on Friday and looked poised to end the month higher.
After a bull-run that took off late last year amid noises about concrete steps to revive a moribund Japanese economy, May has been characterized by huge waves of profit taking in the Nikkei. Thursday's late stock-market dive came exactly a week after the market tumbled more than 7 percent in its largest one-day fall since the March 2011 tsunami and earthquake.
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"While the [Nikkei] volatility is contained in Asia for the time being, it is making U.S. investors nervous," said Kathy Lien, managing director at BK Asset Management in a note. "If Japanese stocks continue to fall it could indirectly trigger a top in U.S. markets as uncertainty spreads around the world."
Most equity strategists remain upbeat about the outlook for the Nikkei, which is still up more than 30 percent for the year. That puts it ahead of year-to-date gains of around 16 percent in U.S. stock markets and a rise of about 13 percent in London's FTSE-100.
"It certainly has been an exciting week for Japan markets but you have to put the sell-off into the context of how far the Nikkei has risen," Alexander Treves, head of equities Japan at Fidelity Worldwide Investment in Tokyo, said. "The fundamental story remains intact and people were looking for an excuse to sell."
According to analysts the outlook for the Nikkei remains positive and news this week that Japan's public pension fund, worth over $1 trillion, is mulling a change in its portfolio strategy that could allow its investments in Japanese equities to grow, add to investor optimism.
— By CNBC.Com's Dhara Ranasinghe; follow her on Twitter @DharaCNBC