Tokyo's Nikkei average lost initial gains to close lower on Tuesday for the second straight day as investors became nervous about the recent rally and opted to take profits in gainers such as banks and property firms.
Analysts said the yen's strength against the dollar was also depressing sentiment and domestic investors took to the sidelines ahead of the end of Japan's financial year on Wednesday.
But there was some support from growing optimism over Japan's economic recovery, which encouraged foreigners and small investors to pick up selected telecom and technology stocks.
The Nikkei ended the session down 0.21 percent at 11,693.68. It earlier rose as high as 11,869.00, its best intraday level since June 4, 2002. The broader TOPIX index lost 0.31 percent to 1,175.51, closing lower for the first time in six days.
"Market fundamentals are still solid, but buyers are reluctant to build up new positions ahead of the fiscal year-end," said Masatoshi Sato, a senior strategist at Mizuho Investors Securities.
"There's growing optimism about Japan's economy, but at the same time there's caution over the market's recent rally, and uncertainties on the currency market and the US economic recovery are discouraging buyers from buying more."
Trading slowed, with 1.301 billion shares changing hands, the lowest total since February 26 and down from 1.467 billion on Monday. Decliners outnumbered gainers 862 to 563.
Banks were sold, with industry leader Mizuho Financial Group losing 2.02 percent to 437,000 yen and Mitsubishi Tokyo Financial Group Inc falling 2.86 percent to 1.02 million yen. The banking sector subindex IBNKS. dropped 2.02 percent, making it the biggest losing sector.
Investors also dumped other recent high-flyers such as real estate firms, as growing optimism over Japan's economic recovery had boosted the sector in recent sessions. Shares in Mitsui Fodosan Co, Japan's biggest real estate developer, fell 3.02 percent to 1,283 yen. Still, the shares are up nearly 37 percent since the start of 2004.
Meanwhile, investors' appetite grew for telecom stocks as the sector was seen lagging the market's recent rally.
NTT DoCoMo Inc, Japan's largest cell phone operator, rose for a third straight day, adding 2.19 percent to 233,000 yen. Smaller rival KDDI Corp was up 3.53 percent at 586,000 yen.
Despite concerns about the currency market and Wall Street, some analysts were optimistic, saying the Nikkei would top the psychologically important 12,000 level in April after banks, pension funds and other domestic financial institutions allocate new money from April 1 - the start of Japan's fiscal year. "Investors, including foreigners and individuals, are still hungry, and that's why the recent strength of the yen (against the dollar) isn't hitting electronics stocks like Sony," said Fujio Ando, a market analyst at Chibagin Asset Management.
Takashimaya Co Ltd rose 1.76 percent to 1,156 yen after the major department store said on Monday that it had lifted its parent-only net profit forecast to 2.7 billion yen ($25.60 million) for the year to the end of February, helped by strong sales of clothes. It previously forecast a net profit of 1.7 billion yen.