Stocks closed broadly lower as investors pummeled financials on concerns about a potential government levy on banks, while Alcoa's disappointing results stoked unease about the economic recovery.
Technology stocks also helped lead the selloff, with the Nasdaq losing more than 1.5 percent. The major averages were off their lows for the day but threatened to post the market's second losing day of 2010.
President Obama is considering a levy on financial services firms to recoup bailout losses as part of the fiscal 2011 budget he will unveil in February. Investors feared that a levy might hurt bank profits at a time when the sector was trying to recover from the financial crisis, analysts said.
"Talk of a levy creates even more uncertainty for the market and that's the reason for the financials to pull back," said Quincy Krosby, market strategist with Prudential Financial in Newark, New Jersey. "The sooner they can clarify the rumors the better for the market. Investors need to hear the specifics regarding this potential proposal."
Alcoa got earnings season off on a sour note Monday and other prominent companies looked ready to follow suit. The aluminum giant's shares weighed on the Dow, as did a warning from Chevron.
Market also were rattled a bit as China announced an increase in the reserves banks are required to carry, a move tantamount to signaling an interest rate hike.
Though earnings season is in low gear so far, the early disappointments were enough to rattle investors.
Elsewhere, KB Home's earnings actually beat Wall Street estimates, but shares fell after the company's CEO warned that a housing recovery remains uncertain. The SPDRHome Builders ETF fell more than 2 percent.
Chevron had warned Monday that its quarterly earnings would be "sharply lower" than the previous quarter because of weak oil refining margins.
On the indexes, Alcoa was by far the biggest drag on the Dow 30 and the S&P 500, with Bank of America and Caterpillar, coming off a big day, also hitting the bluechips.
Banks took a hit from fears that the industry was in Washington's cross hairs, sending the SPDR Financial ETF down more than 1.5 percent in afternoon trading.
American Express was the index's leading gainer.
Hartford Financial Services led S&P gainers as it doubled its forecast due to strong underwriting profitability, rising account values and lower costs.
While financials were broadly lower, Hartford pushed insurance companies to the front of the market leaders. The Dow Full Line Insurers index gained 2 percent.
Among the weakest Dow sectors were aluminum (-10.5 percent) and tires (-4.2 percent).
Industrials have led the S&P in 2010, up 6.4 percent prior to Tuesday's trading. Telecoms have fell 2.6 percent to be the worst performer on the index, which is off to its best start since 1987.
The Nasdaq tech barometer was a sea of red, with chipmaker Nvidia giving back some of the mammoth 32 percent gains the company has seen over the past two months.
Also, Electronic Arts shares tumbled after the video game leader lowered its full-year outlook for the second time in two months, citing a lack of strong titles to lure customers.
On the positive side, Infosys Technologies raised its profit outlook as India's second-biggest software services exporter benefiting from the improved global economy.
MGM Mirage shares jumped after Goldman Sachs upgraded the company to a "buy."
KKR Financial shares fell after the San Francisco-based bank said charges could cause it to lose as much as 5 cents a share, against analyst estimates of a 27-cent profit and last year's 42-cent profit.
The earnings calendar is otherwise light, but did include contrasting reports from supermarket chains Great Atlantic & Pacific Tea Company and Supervalu.
Great Atlantic shares slumped after the company reported its sixth consecutive quarterly loss, while Supervalu gained as it beat expectations and affirmed its full-year outlook.
Volume was weak, with about 750 million shares changing hands with less than an hour left of trading on the New York Stock Exchange. Breadth was negative, with losers beating gainers nearly 3 to 1.