Japan-China tensions trigger Nikkei 225 sell-off as tourism stocks plunge

What happened

Diplomatic tensions escalated after Prime Minister Sanae Takaichi stated in parliament on 7 November that a Chinese military action against Taiwan could constitute an existential threat to Japan, potentially warranting a military response from Tokyo. Beijing responded over the weekend by issuing a travel advisory and expressing concerns regarding the safety of Chinese nationals in Japan.

The Chinese Foreign Ministry asserted that recent statements on Taiwan had undermined the foundation of bilateral relations and called upon Takaichi to retract her remarks. On Monday, Takaichi characterised her comments as 'hypothetical' and pledged to refrain from making similar statements in parliamentary proceedings.

Nikkei plunges below 50,000 and yen weakens

Heightened diplomatic tensions with China triggered significant investor concern, with travel and retail-oriented equities experiencing substantial sell-offs following Beijing's advisory to Chinese citizens against visiting Japan. Beauty and personal care company Shiseido witnessed its shares decline by 12%, while department store operator Isetan Mitsukoshi fell over 11%, and Ryohin Keikaku, parent company of Muji, shed more than 9% of its market value.

Combined with concerns regarding elevated valuations in US technology equities, the Nikkei 225 declined 3% across the first two trading sessions this week, falling beneath the 50,000 threshold. The yen simultaneously weakened, breaching 155 against the dollar.

Market vulnerability and economic backdrop

Recent developments reinforce external perceptions of Takaichi's hardline conservative positioning, which has clearly unsettled Beijing. While the market reaction appears pronounced, the underlying concerns are legitimate.

The timing proves particularly inopportune given Japan's fragile economic landscape. Japan's third-quarter gross domestic product (GDP) contracted by 1.8% on an annualised basis, marking the first contraction in six quarters. The deceleration stemmed from a sharper decline in net exports and softened private consumption. Households continue to grapple with rising costs amid anaemic real wage growth, while the broader economy confronts external headwinds including US tariffs. Domestic consumption has failed to generate meaningful momentum in retail sales, rendering tourism revenues increasingly critical to economic growth.

Tourism impact

Visitors from mainland China, Hong Kong and Macau represent approximately 27% of all foreign arrivals to Japan in 2024, totalling close to 9.8 million visitors. Should tensions persist, tangible impacts on retail and tourism-related equities could materialise. That said, visitors from other regions may partially offset this demand contraction. Notably, Japan's recent decision to triple the tourism tax to ¥3000 suggests authorities believe current visitor volumes exceed optimal levels, indicating some buffer capacity exists.

It is worth noting that certain equities most severely affected in this episode, such as Shiseido, were already contending with separate operational challenges—the geopolitical tensions merely amplified pre-existing vulnerabilities.

Trade implications

Should tensions intensify further, disruptions could extend into the trade relationship, which remains asymmetric yet mutually significant. Japan maintains a ¥6.4 trillion trade deficit with China in 2024 and depends heavily on Chinese imports for consumer electronics, household appliances and critical rare-earth metals—inputs essential for Japanese manufacturers to sustain export competitiveness. Conversely, Japan dominates the global supply of semiconductor manufacturing equipment and precision machinery crucial to China's technology sector and industrial ambitions. Any sustained trade disruption would prove detrimental to both economies.

Technical analysis

Nikkei 225

The Japan 225 index has declined approximately 8% from its early November peak, but given it continues trading above the 200-day moving average (MA), the medium-term ascending trend remains intact. The trend line originating from early April is likely to provide support around 48,000. The Bollinger Bands also indicate an oversold condition, which could potentially drive a technical rebound towards immediate resistance around 51,500. However, should the index breach below 48,000, the next material support lies near 45,000.

Figure 1: Japan 225 daily price chart

USD/JPY

USD/JPY has gained momentum following the breakout in early October after Takaichi's election as president of the Liberal Democratic Party. The pair currently trades at the resistance range of 154.8-156. Should the US dollar strengthen further beyond this resistance range, January's high at 158.9 will come into focus. Conversely, a rejection below 156 would likely suggest consolidation within the 153-155 range, with 151.6 acting as key support.

Figure 2: USD/JPY daily price chart