Investors locked in profits Thursday following big gains earlier in the week. Weak demand at a Treasury bond auction also touched off worries about the government's ability to raise funds to fight the recession.
Upbeat reports on the job market and retail sales initially sent stocks higher but the gains eroded by midmorning as traders asked "What's next?" and cut back their holdings following the 4.8% gain so far this week in the Standard & Poor's 500 index.
"This is a market that is starting to bake in a lot of positive surprises," said Craig Peckham, a market strategist at Jefferies & Co.
Major stock indicators all fell at least 1%, including the Dow Jones industrial average.The Nasdaq composite fell more than 2%.
Jitters about weak demand at a government debt auction fanned the market's pullback. Bond prices tumbled following an auction of 30-year Treasury bills in which the government had to pay greater interest than expected. That was worrisome to traders because it could signal that it will become harder for Washington to finance its ambitious economic recovery plans.
The yield on the benchmark 10-year Treasury note jumped to 3.28% from 3.16% late Wednesday. The yield on the 30-year long bond jumped to 4.27% from 4.11% Wednesday.
The pullback came ahead of the formal release of results from the government's stress tests of bank balance sheets, after the closing bell. News reports have already given investors a decent idea of what to expect so analysts aren't predicting big surprises.
The slide in stocks, which erased Wednesday's advance, followed a massive two-month rally that brought the S&P 500 index up more than 30% from 12-year lows reached in early March.
At the close of trading, the Dow fell 12, or 1.2%, to 8,410, a day after the blue chips jumped 102 points to close above the 8,500 level for the first time in four months. The index is down only 4.2% for the year.
The S&P 500 index fell 12, or 1.3%, to 907, and the Nasdaq composite index fell 43, or 2.4%, to 1,716.
The S&P 500, a widely used benchmark for mutual funds and professional investors, is now about breakeven for the year. Analysts said it wasn't surprising that the market would take a break after such big gains.
Technology shares posted the biggest losses Thursday after security software maker Symantec symc posted weaker-than-expected results. Retailers were mixed even after many of them, including Wal-Mart Stores wmt, reported better-than-expected April sales.
"The fact that we're seeing the retailers sell off on these positive surprises suggests the bar has been raised on what companies need to do to take stocks higher," Peckham said.
Wal-Mart said sales of Easter merchandise and more shoppers in its stores helped its sales jump 5%, much more than the 2.9% rise analysts had forecast.
The well-being of retailers is key to the economy because consumer spending accounts for more than two-thirds of economic activity.
Symantec reported a loss for its fiscal 2009 fourth quarter, hurt by a hefty goodwill impairment charge and lower-than-expected revenue.
Financial stocks mostly fell after big gains Wednesday and ahead of the government report cards on banks. The tests, designed to determine which banks would need a stronger capital base if the economy weakens, are at the crux of the Obama administration's plan to fortify the financial system. The market rallied this week ahead of the results, despite some initial concerns that the tests would show more pain in the industry.
In economic news, new applications for unemployment benefits fell last week to the lowest level in 14 weeks. The Labor Department's tally of new jobless claims fell to 601,000 from 631,000 the previous week, well below the 635,000 economists had been expecting. A four-week moving average of initial jobless claims that smooths out fluctuations fell from a high in early April.
The employment reading follows a better-than-expected private snapshot of the labor market on Wednesday and comes a day ahead of the government's April employment report. It is often regarded as the most important economic news each month because a drop in unemployment could bolster everything from banks to retailers if consumers can continue to make mortgage payments and go shopping.
There were also reports showing that productivity rebounded slightly in the first quarter while wage pressures eased.
Federal Reserve Chairman Ben Bernanke, addressing a Fed conference, said a broader approach is needed for strengthening oversight of the banking system and said information gleaned from big bank "stress tests" should pave the way for improvements on that front.
The dollar rose against the euro and the British pound after the European Central Bank cut its key interest rate a quarter point to 1%. Gold prices rose.
Light, sweet crude rose $1.08 to $57.42 per barrel on the New York Mercantile Exchange.
Overseas, Japan's Nikkei stock average jumped 4.6%. Britain's FTSE 100 rose less than 0.1%, Germany's DAX index fell 1.6%, and France's CAC-40 fell 1%.