The Nikkei and Shanghai Comp - Unlikely Companions
Japan's blue-chip stock index doesn't usually take its cue from China's stock market but that has changed this week as the Shanghai Composite slumped to its lowest level in more than four years.
While the sell-off in the Nikkei has not been as marked as the one in Shanghai this week, analysts say the drubbing in Chinese stocks has come at a bad time for Japanese shares which were showing signs of a rebound after falling sharply from a five-and-a-half-year high hit in May.
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"The China issue is another macro shock and all markets will respond to that," said Ben Collett, the head of Asian equities at Sunrise Brokers in Hong Kong. "The Nikkei isn't necessarily following the full scale of the sell-off in China, but there is a lack of clarity about China and that is having an impact."
The Nikkei stock index is up roughly 4.8 percent from a two-month low hit earlier this month, but has struggled to break above the key 13,000 level this week as the Shanghai Composite tumbled as much as 10 percent over the course of two days.
In fact, the typical pattern of trade for the Nikkei in the past two sessions has been to open higher only to be dragged lower in afternoon trade as China stocks headed south. Japan's stock market rose almost 2 percent in early trade on Thursday.
"The Nikkei has been moving along with the Shanghai Composite. There was an expectation that the Shanghai Composite would go up [Wednesday] and Japanese futures rallied and then they fell with China," Harry Ida, senior analyst at Thomson Reuters in Tokyo told CNBC Wednesday.
He added that the weakness in Chinese shares was also boosting the yen's value against the U.S. dollar, with yen strength further undermining Japanese stocks.
A credit squeeze in Chinese money markets this month has raised concerns about the outlook for the world's second biggest economy, which is already showing signs of weakness. Recent data have proved to be on the weak side and a number of economists have slashed their 2013 forecasts for gross domestic product growth.
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"There are a lot of companies in Japan that would suffer a lot if growth in China weakens sharply. For instance, the construction and machinery sectors, automakers and shippers," said Sunrise Brokers' Collett. "China is one of Japan's biggest trading partners so what happens there is important."
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Gary Evans, the global head of equity strategy at HSBC, added: "We have cut our forecasts for China growth. With interest rates spiking up, people are taking that as a cue the government is being tough on reforms."
"So, in the meantime you have to expect Chinese equities to be quite volatile and quite weak," he told CNBC Asia's "Squawk Box" on Thursday.