"If Wall Street falls, the Nikkei will fall," said Martin Keeble, the joint head of dealing at Schroders Japan. "Even if Wall Street doesn't fall, the Nikkei will still go down because Japan is in recession."
The benchmark Nikkei 225 could slide as low as 13,500, said Garry Evans, a strategist at HSBC Securities (Japan). "People are still too optimistic about earnings," he said. "We can look at some more big, bad surprises in the next few days ... there are a lot more big worries like Hitachi."
Hitachi said on Thursday that it expects to report a net loss of 250 billion yen (pounds 1.1bn) for the year to 30 March.
Market participants will also be watching the progress of legislation to clean up Japan's ailing banking system. The opposition and the ruling Liberal Democratic Party are at loggerheads over use of public funds to bail out struggling banks. The proposed merger between Long-Term Credit Bank of Japan and Sumitomo Trust and Banking is the focus of the debates. "If a compromise is reached next week, I would expect that to support bank stocks, but if we get no progress on LTCB then fears about uncontrolled bankruptcies in the financial sector will increase," said Celia Farnon at Nomura.
Traders will also be watching for any developments from this weekend's meeting between Finance Minister Kiichi Miyazawa and US Treasury Secretary Robert Rubin. "If we don't get anything concrete from the meeting, we could test 13,700," said Tsuguya Onozuka at Yamatane Securities.
Japanese bonds are likely to trade little changed next week, as investors watch the stock market for signs that recent declines have ended. The benchmark Japanese government bond, maturing in September 2005, ended last week unchanged, though at one point the yield fell to a record low. Bonds rose as stocks fell and investors looked for the safety of fixed- income investments, and they fell as stocks recovered.
"Given shaky stocks, bond yields will go lower, but the [Japanese] stock market could get support from the government," said Masahiro Kami at SB Investment Management.