Wall Street plunged Tuesday, driving the Dow Jones industrials down 370 points after investors saw an unexpected contraction in the service sector as evidence that the economy is sinking into recession.
It was the Dow's biggest percentage drop in almost a year.
The volatility that pummeled stocks in January returned with the news that the service sector shrank last month for the first time since March 2003. The report from the Institute for Supply Management wiped out the nascent optimism about the economy that had sent stocks surging higher last week.
"The report drives a nail into the coffin from investors' minds that we're in a recession," said Todd Salamone, director of trading at Schaeffer's Investment Research. "That doesn't mean stock prices in the months ahead will be lower. But when you see headline numbers like this, there tends to be a reactionary sell."
The ISM said its index of service sector activity, which accounts for about two-thirds of the economy, dropped below 50, a level that indicates contraction. The market had expected another month of growth, and the disappointment contributed to Tuesday's $500-billion loss in the Dow Jones Wilshire 5000 Composite Index, an index that measures the movement in 5,000 U.S. stocks.
Alongside the Labor Department's report last week showing the first monthly U.S. jobs decline in more than four years, the data on the service sector - which includes businesses ranging from restaurants to retailers to banks - was particularly worrisome to investors.
Though Wall Street hopes the Federal Reserve will keep slashing interest rates to stoke the economy, some believe the central bank, which lowered rates 1.25 percent in just over a week last month, acted too late. Rate cuts take several months to take effect, and moreover, many analysts are skeptical that rate cuts are the correct remedy for an economy saddled with bad debt from a housing market implosion.
Fitch Ratings' plans to lower the rating on more than $100-billion wrapped up in bond funds called collateralized debt obligations added to the concerns plaguing Wall Street. Downgrades would mean the securities - many of which are backed by mortgages - are worth even less than many investors thought. That could cause more problems for struggling banks, brokerages and bond insurers hurt by investments in mortgages that went sour.
The Dow fell 370.03, or 2.93 percent, to 12,265.13, after falling 108 points on Monday. Tuesday's slide was the blue-chip index's largest one-day percentage drop since it lost 3.3 percent on Feb. 27, 2007, and its largest point drop since it fell 387 points on Aug. 9.
The broader Standard & Poor's 500 index lost 44.18, or 3.20 percent, closing at 1,336.64, while the Nasdaq composite index tumbled 73.28, or 3.08 percent, to 2,309.57.
Bond prices jumped as investors sought the safety of government-backed debt. The yield on the benchmark 10-year Treasury note, which moves opposite its price, sank to 3.56 percent from 3.64 percent late Monday.
On Tuesday, the biggest losers in the stock market were banks, which have already suffered huge losses in their investment portfolios last year and are now socking billions of dollars away to prepare for debt-burdened consumers to stop making payments.
Dow component Citigroup fell $2.17, or 7.4 percent, to $27.05, while JPMorgan Chase & Co., another Dow component, fell $2.33, or 5 percent, to $44.28. Bank of America fell $1.66, or 3.8 percent, to $42.37, and Wachovia fell $1.35 to $34.18.