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Dow Sheds 1.5% as Investor Optimism Fades

Stocks finished off their lows but still logged a triple-digit loss Thursday as the Fed's lowered outlook and disappointing economic data rattled investor confidence.

The Dow Jones Industrial Average lost about 130 points, or 1.5 percent. The S&P 500 and Nasdaq were down nearly 2 percent.

One of the big things weighing on the market today, was the Standard & Poor's downgrade on the UK economy to "negative" from "stable."

It not only raised doubts about the UK's credit rating but also stoked concern about the U.S.'s credit rating.

"The market views those two countries — the UK and the U.S. — as relative twins," Pimco's Bill Gross told CNBC.

He doesn't think the U.S. will lose its triple-A rating anytime soon, but the market views it as an increasing possibility, he said.

A slew of economic data that came out this morning disappointed investors already feeling less optimistic after the Fed slashed its full-year outlook for the economy and projected an increase in unemployment.

The Philadephia Fed branch reported its gauge of regional manufacturing activity improved slightly in May — to minus-22 from minus-24 — but missed economists' target.

Initial jobless claims dropped by 12,000 to a seasonally adjusted 631,000 last week, slightly higher than expected, and continuing claims surged to another record. Economists noted that the drop in the headline number was mostly due to a reversal of the prior week's jump in auto layoffs, which sparked concern that layoffs aren't tapering off at as fast a pace as many had hoped.

"We'd be very surprised if the underlying trend in claims were to start rising again, but these latest numbers do not encourage the idea that the pace of layoffs is dropping sharply," Ian Shepherdson, chief U.S. economist at High Frequency Economics, wrote in a note to clients.

Adding to the worry on the trading floor: This is one of the weeks that the jobless report was sampled for the payrolls report.

The Congressional Budget Office backed the worries about unemployment, saying the economy will start growing again in the second half but unemployment will keep rising through 2010, peaking above 10 percent.

Investors shrugged off the morning's one better-than-expected data point: Leading indicators rose 1 percent in April, the first increase since last June.

“We’re certainly at a point now when these so-called green shoots have to actually develop into some kind of actual plants,” Steve Massocca, managing director of Wedbush Morgan, told CNBC.

For this stock-market rally to continue, we’re going to have to see some actual improvements in the economy, Massocca added.

Energy stocks including ExxonMobil and Chevron led the decline as oil prices fell amid this fresh wave of worry about the economy.

Bank stocks, which typically lead market retreats, actually enjoyed some gains after Goldman Sachs upgraded some names in the sector, citing capital raised by the banks and second-quarter earnings prospects.

Goldman rates Morgan Stanley at "buy" and PNC, US Bancorp and Wells Fargo at "neutral." Trust banks such as Bank of New York Mellon, Northern Trust and State Street were upgraded to "attractive."

Alcoa , Caterpillar and Boeing were the biggest decliners on the Dow.

Boeing backed its full-year outlook of $4.70 to $5 a share. The aerospace giant said it has adequate financing for 2009 and that it's on track to cut 10,000 jobs this year.

There were three Dow stocks higher: General Motors , JPMorgan and Wal-Mart .

The government is getting close to providing more funding for GMAC, which would help the company provide more loans for GM and Chrysler vehicles.

Xerox skidded after the copier maker named Ursula Burns as CEO, succeeding Anne Mulcahy, who will retire July 1 but will remain chairwoman of the board.

Barnes & Noble rose after the bookseller beat expectations and raised its outlook, helped by cost-cutting efforts and better-than-expected sales.

OpenTable soared more than 20 percent on its debut on the Nasdaq. Shares of the online restaurant-reservation service were priced at $20late Wednesday, well above the expected range of $16 to $18. It's the first Nasdaq IPO of 2009.

Treasury Secretary Timothy Geithner is back on Capitol Hill, testifying before a House Appropriations subcommittee. On Wednesday, he told a Senate panel that the financial system was "starting to heal."

And Philadelphia Fed President Charles Plosser will speak on the economic outlook at 7 pm in New York.

Still to Come:

THURSDAY: Philly Fed report; leading indicators; Geithner in the House; Fed's Plosser speaks; Earnings from Gap and Aeropostale after the bell
FRIDAY: Earnings from Campbell Soup

Send comments to cindy.perman@nbcuni.com.