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By Sophie Knight
TOKYO (Reuters) - Japan's Nikkei average sagged on Tuesday as investors cut their exposure to exporters and riskier stocks, awaiting a ruling from German's constitutional court on the legality of the European bailout fund and the U.S. Federal Reserve policy meeting this week.
The Nikkei dropped 0.7 percent to 8,807.38, but held above its 75-day moving average support level at 8,780.30.
Germany's constitutional court holds the fate of the euro in its hands when it rules whether the European Stability Mechanism (ESM) can go ahead, after already holding it up for several months.
"A lot of people assumed that the ESM would pass without any problems but I think there is still quite a bit of opposition in Germany to it, which could be dangerous," said Masayuki Otani, chief market analyst at Securities Japan.
Cyclical stocks, which have a relatively high correlation to the health of the economy, came under pressure. Industrial robot maker Fanuc Corp was down 1.6 percent, Mazda Motor Co <7261.T> was off 2.1 percent and Toyota Motor Corp lost 1.7 percent.
Investors have had high hopes that the U.S. Fed will announce another round of stimulus, or quantitative easing, after it concludes a two-day meeting on Thursday - but some are concerned that such a move could strengthen the yen, pinching exporters' overseas revenues.
"The style drift in the market today is such that cyclicals and financials are being shunned and de-weighted and autonomous growth stocks which are non-dependent on the yen," said a senior trader for a foreign bank who said 70 percent of his orders on Tuesday were short sales.
Social gaming company Gree Inc <3632.T>, which derives most of its revenue from the domestic market, gained 2.8 percent to four-week high and was the second-most traded stock by turnover on the main board for much of the day, behind its rival DeNA Co Ltd, which was up 1.1 percent.
Investors have been reassured that both Gree and DeNA's earnings have recovered, the trader said, after their stock prices lost almost 50 percent in May on fears that revenue would be crimped by the loss of their "complete gacha" games due to gambling regulations.
Societe Generale said another round of monetary policy easing from developed to emerging economies could be good for the Japanese equity market as it would push bond yields at the long end of the yield curve to even lower levels, leading investors to seek assets with higher returns.
In a note, it said that among its investment recommendations, British and Japanese equities offer a return of nearly 2 percent above domestic government bond yields.
The Nikkei is up 4.2 percent so far this year, while yields on benchmark 10-year Japanese government bonds were quoted at 0.795 percent on Tuesday, down 18.5 basis points since the beginning of 2012.
The broader Topix <.TOPX> index lost 0.7 percent to 732.26 in very light trade, with volume at just 80 percent of its full daily average for the past 90 days.
TECH STOCKS BEARISH
Technology stocks extended their losses after Intel Corp
Shinko Electric Industries <6967.T>, Ibiden Co Ltd <4062.T>, Tokyo Electron Ltd <8035.T> and Advantest Corp <6857.T> were down between 1 and 3.1 percent.
Elsewhere, Panasonic Corp <6752.T> dropped 1.7 percent after Moody's Investors Service cut the consumer electronic company's rating by two notches to Baa1.
Japan Tobacco Inc <2914.T> rebounded 2 percent after slumping 8.4 percent in the previous two sessions on concerns about more regulation in Europe after the French government said it was looking at raising tobacco prices in a bid to reduce smoking rates.
(Additional reporting by Dominic Lau; Editing by Eric Meijer)