The Nikkei share average gave up early gains to close 0.34 percent lower on Monday on profit-taking in such index heavyweights as Tokyo Electron Ltd after the index topped 16,000 for the first time in a week.
There were signs of foreigners selling more shares to cash in on recent gainers such as food stocks, while concerns about industrial output data due to be issued before the open on Tuesday also curbed buying.
Yumi Nishimura, manager at Daiwa Securities SMBC's investment advisory section, said if the data comes in stronger than expected, that would bolster the market which has been overshadowed by recent turbulence in the US and emerging markets.
"But there are cautious views that the data could reflect corporate managers' conservative earnings outlooks for the current business year," she said.
Technical analysis of inventory cycles show signs that there will be an adjustment in inventory build-ups in the high-tech sector in coming months, but economists have said a protracted economic downturn is unlikely.
A Reuters poll of economists produced a median forecast of a 1.8 percent rise in production in April from March. The market also keeps an eye on forecast figures for May and June.
The Nikkei fell 55.08 points to 15,915.68, reversing an earlier rise to as high as 16,111.54. The index rose 1.77 percent on Friday.
However, the broader TOPIX index held on to gains on advances in shares of banks and steel makers, rising 0.15 percent to 1,616.17.
In early April the Nikkei average topped 17,500 on hopes that corporate earnings would post double-digit growth in the year to March 2007, helped by a recovery in consumer and corporate spending at home.
Tatsuo Nishimura, portfolio manager at Meiji Dresdner Asset Management, said the market's major concern now is waning appetite by foreign investors, the main driver behind the Nikkei's 40-percent rally last year.
The latest exchange data showed that foreign investors sold a net 359.72 billion yen ($3.19 billion) of Japanese stocks in the week ended on May 19, the heftiest sales in a month.
"Foreigners are withdrawing money for now as the best time looks already behind us," Nishimura said. "I believe, however, they would be back if and when companies raise profit forecasts."
Among gainers, bank shares rose for a second session on Monday, following an industry-wide sell-off last week on news that the government would next month sell shares it holds in Mitsubishi UFJ Financial Group (MUFG) worth about 480 billion yen ($4.28 billion).
The sale is part of an effort by the bank, created in a merger last October, to replay taxpayers' funds injected into one of the bank's predecessors in the 1990s.
Shares of MUFG, the world's biggest bank by assets, rose 2.7 percent to 1.54 million yen. Rival Mizuho Financial Group Inc was up 0.3 percent at 920,000 yen.
Steel makers such as Nippon Steel Corp rose after European steel firm Arcelor said it would buy Russia's Severstal, sparking hopes that industry consolidation could boost steel makers' pricing power.
"The proposed merger would have an indirect impact on Japanese companies as that would help stabilise the global steel market," said Masaru Okawa, an analyst at Nomura Securities.
Shares in Japan's biggest steel maker Nippon Steel gained 0.7 percent to 431 yen. No 2 JFE Holdings Inc advanced 1.7 percent to 4,860 yen.
In contrast, Tokyo Electron, the world's second-biggest chip equipment maker, was down 2.4 percent at 8,040 yen. Another Nikkei heavyweight Canon Inc, the world's biggest digital camera maker, lost 1 percent to 8,050 yen.
Profit-taking also pulled down Japan Tobacco Inc, the world's third-biggest tobacco company, which lost 2.7 percent to 402,000 yen. Nippon Suisan Kaisha Ltd, a seafood processing company, lost 2.6 percent to 567 yen. The company's upbeat 2006/07 profit outlook had boosted the shares to a 14-year high of 599 yen last week.
With market holidays in Britain and the United States on Monday, trade saw its slowest day in nearly four weeks with just 1.55 billion shares changing hands on the Tokyo exchange's first section. Decliners beat advancers, 878 to 692.