Stocks fall as traders await Fed's take on economy

A recurrence of investors' anxiety about the economy gave Wall Street its biggest loss in five weeks.

The major indexes fell 1% Tuesday as investors feared that the market's steep gains in the past month could unravel if the economy doesn't show more signs of strengthening. Warnings about the health of banks and uneasiness ahead of the Federal Reserve's economic statement Wednesday led investors to dump financial stocks and wade into defensive areas like consumer staples companies and government debt.

Meanwhile, a record 10th straight monthly drop in wholesale inventories brought a fresh reminder that a recovery in the economy is likely to be gradual.

But many analysts said investors aren't panicking. They were taking a much-needed pause following a rally that seemed to be going at breakneck speed. The Standard & Poor's 500 index had reached at its highest level since last fall, rising 15% in just four weeks and 49% from a 12-year low in early March.

"This sort of give-and-take is quite healthy," said Erik Davidson, managing director of investments at Wells Fargo Private Bank in Carmel, Calif. "You're up 50% in five months. That's 10% a month. In quote-unquote normal markets that's five years worth of returns."

Moreover, traders often become jittery when the Fed policymakers meet to discuss interest rates. It is widely expected that the central bank will hold interest rates at their historic low of essentially zero, but investors are waiting to see what the Fed has to say about the economy when the meeting concludes Wednesday.

"It's pretty clear that a lot of people are pulling back any bets pending what is going to happen with the Fed," said Max Bublitz, chief strategist at SCM Advisors in San Francisco.

There were some troubling developments during the day, however. Downbeat comments from analysts about banks weighed on the market. Analyst Richard Bove of Rochdale Securities predicted that bank earnings won't improve for the second half of the year and that many companies will post losses.

"It just takes the euphoria feelings off the table," said Dave Rovelli, managing director of trading at brokerage Canaccord Adams in New York, referring to Bove's comments and recent optimism among investors.

With many traders on vacation, volume was light, which tends to skew price moves.

The Dow Jones industrial average fell 96.50, or 1%, to 9,241.45. It was down 121 points at its low of the day. The Dow slipped 32 points Monday.

The broader S&P 500 index fell 12.75, or 1.3%, to 994.35.

It was the biggest drop for both the Dow and the S&P 500 index since July 7.

The Nasdaq composite index fell 22.51, or 1.1%, to 1,969.73, while the Russell 2000 index of smaller companies fell 9.75, or 1.7%, to 562.12.

About three stocks fell for every one that rose on the New York Stock Exchange, where volume came to 1.2 billion shares compared with 1.1 billion Monday.

The Chicago Board Options Exchange's Volatility Index spiked in a sign of investors' nervousness. The VIX, also known as the market's fear index, rose 4% to 25.99, its highest level in a month. It is down 35% in 2009 and its historical average is 18-20. It hit a record 89.5 in October at the height of the financial crisis.

Bond prices jumped. The gains followed a solid showing at the first of the week's three auctions for a record $75 billion in debt. Prices often fall when the government introduces supply to the market. The sale Tuesday was for $37 billion in three-year notes and the government will auction $23 billion in 10-year notes Wednesday.

Investors are watching for a drop in buyers because that could force the government to increase the interest it pays, which would drive up borrowing costs for consumers and slow an economic recovery.

The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 3.67% from 3.78%.

Among banks, Citigroupc fell 25 cents, or 6.4%, to $3.69. Bank of Americabac fell 83 cents, or 5%, to $15.85.

Bond insurer MBIA mbi tumbled 78 cents, or 12.6%, to $5.39 after J.P. Morgan Securities cut its rating on the stock over concerns the company could face steep losses from bad debt.

The KBW Bank Index, which tracks 24 of the nation's largest banks, slid 4.4%.

Wal-Mart Storeswmt rose 32 cents to $50.04 as investors looked for safe-haven investments.

The day's economic readings were mixed. The Commerce Department said inventories fell 1.7% in June. That was nearly double the drop economists had expected. The drop has contributed to the recession.

The Labor Department said productivity — which measures the amount of output per hour of work — grew a greater-than-expected 6.4% during the second quarter.

In other trading, crude oil fell $1.15 to settle at $69.45 a barrel on the New York Mercantile Exchange.

The dollar was mixed against other major currencies, while gold prices fell.

Overseas, Britain's FTSE 100 fell 1.1%, Germany's DAX index tumbled 2.4%, and France's CAC-40 dropped 1.4%. Japan's Nikkei stock average rose 0.6%.