Stocks pared losses, although continued to trade lower, as buyers stepped into the market in afternoon trading even as investors remained unnerved by the escalating nuclear crisis in Japan.
The Dow Jones Industrial Average fell more than 135 points, coming back from a nearly 300 point drop shortly after the market opened, and after dropping 51 pointson Monday.
Most Dow components fell, led by Intel , Cisco and Bank of America , while Chevron gained.
The S&P 500 and the tech-heavy Nasdaq both fell less than 1 percent, after dropping more than 2 percent earlier. Intraday, the Nasdaq fell to below the level where it started the year.
The CBOE Volatility Index, widely considered the best gauge of fear in the market, soared more than 13 percent, to nearly 24, after skyrocketing more than 25 percent at the start of trading.
All key S&P 500 sectors fell, led by utilities, technology, and financials.
Stocks trimmed losses further in the final hour of trading after initially gaining ground after news the U.S. Federal Reserve's policy making committeewould continue its massive bond buying program through June, even as policymakers noted growing strength in the economy. The Fed also said it would leave interest rates unchanged.
"I think, as traders tend to do, they see things as an opportunity," said Doreen Mogavero of Mogavero & Lee. "I’m not surprised to see a rally in the afternoon," Magavero said, but added, "I’m not sure how it holds. Even though we are doing better than this morning, we are still not doing well."
Trading on Wednesday will take cues from what happens in Japan overnight, she said.
The Fed's policy setting committee appeared to "cut and paste" statements from its Beige book report on regional economic conditions, and recent speeches by Fed Chairman Ben Bernanke, in crafting their statement today, said John Canally, economist at LPL Financial.
"This is just another gradual acknowledgement that things are getting better in the economy, and they are begining to worry about inflation," Canally said.
The statement was also a good transition statement as the Fed moves from being worried about deflation, to keeping an eye on higher input costs and their potential effects on the economy. "I think the Fed is still the markets friend here for at least a couple months," he said.
The initial sharp sell-off in stock as trading began was largely triggered by computer selling programs taking cues from declines in overseas markets in the wake of unsettling news about nuclear developments in Japan, said Peter Costa, president of Empire Executions. But buyers stepped in later in day, even before the Fed statement, finding bargains among heavily beaten-up stocks, including chip names.
"You hate to be a buyer on bad news, but there are opportunities in a lot of sectors," Costa said.
The widespread selling began in Tokyo, as stocks there plunged more than 14 percent at one poinafter the quake-hit Fukushima nuclear power plantwas hit by two explosions. A significant rise in radioactive levels added to the anxiety over last week’s disaster, with warnings that winds with radiation could reach Tokyo.
Japan’s economics minister tried to calm investors at a press conference Tuesday, saying there was no reason to close Tokyo markets. The president of the Tokyo Stock Exchange appeared to confirm the markets would remain open in a statement on the exchange's website, although the timing of the statement remained unclear.
"I believe that the Tokyo Stock Exchange in its role as an important social infrastructure should continue to provide opportunities for stock trading," Atsushi Saito, president and CEO of the exchange wrote in a statement. "I would appreciate it if all investors and trading participants would respond in a calm and orderly manner." (Click here for more news on the disaster in Japan).
In addition to the crisis in Japan, investors were absorbing news out of the Middle East. Bahrain declared a state of emergency amid news that troops were sent into the country from Saudia Arabia to quell protests. A soldier from Saudia Arabia was reportedly killed by protesters. (Click here for more on the crisis in the Middle East and North Africa.)
London Brent crude sank more than 4 percent to below $109 a barrel, while U.S. light sweet crude fell more than 3 percent below $98 a barrel, amid expectations that global demand for oil will slow as a result of the crisis in Japan.
The International Energy Agency trimmed its forcast for global oil demand on Tuesday to 1.44 million barrels per day, according to Reuters.
GE rebounded from big losses earlier in the session because of the company's connections to the Japanese nuclear industry, and its potential for lost sales.
The news out of Japan hit utilities and companies active in the nuclear sector, including Exelon , the Southern Company , and Entergy , which all have nuclear plants.
Cameco , a uranium producer, also sank.
Fears about the future of the nuclear industry gave a boost to stocks of renewable energy companies, led by SunPower ,Trina Solar and First Solar , all of which gained more than 6 percent.
Luxury goods also fell, with Coach and Tiffany sinking than four percent as traders anticipate a drop in demand for the sector’s products.
Insurers exposed to the disaster in Japan also sank, including Aflac , Hartford Financial and AIG .
Also hit were Japanese based companies, particularly the automakers, Honda , Toyota and Nissan , while U.S. automaker Ford gained.
Panasonic and Sony also fell.
Chip stocks were among the worst performers on Tuesday amid production and distribution concerns. SanDisk , which jointly operates a chip making factory with Toshiba in Japan, fell more than 4 percent. ON Semiconductor , MEMC Electronic Materials , and Nvidia also tanked, although they were off the lows of the day. Intel's shares were also being affected by a downgrade by Nomura, which cited weak demand for personal computers in cutting its rating on the tech giant to "neutral" from "buy."
Also in tech news, Hewlett-Packard fell despite announcing a 50 percent boost in its quarterly dividend.
As stocks plunged earlier in the session, jittery investors moved into Treasurys. The yield on the 10-year Treasury note fell to 3.27 percent.
"I’m not surprsised by the pressure on the equity markets at all," said Bob Andres, chief investment officer at Merion Wealth Partners. "The fact that equities are overvalued makes them very vulnerable to an outside situation like we’re seeing."
The aftermath of the quake will have an effect on the global economy, "at a point in time where I think the global economy is about to slow down," Andres said. Even without a disaster of this magnitude, Andres had expected stock prices to fall from their lofty levels, and for bond yields to remain at current levels or move lower before the year ends.
"There was no bond bubble," Andres said. "I would argue PE (price-to-earnings) ratios are too high, I would argue that the economy, while we’ve certainly seen some pluses, I believe it’s all been built on government largesse and we’re going to see an end of that shortly."
"I think this is the capitulation," said Keith Springer, president of Springer Financial Advisors, earlier in the session. It's the point, he added, where "anybody who wanted to sell has sold or is selling."
Still, he noted the markets have not fallen far from their highs. By early afternoon, the S&P 500 was off about 5 percent from its mid-February highs, while the Dow was off about 4 percent.
Meanwhile, the dollar rose against a basket of currenciesas a safe haven currency, while gold fell to $1,397 an ounce, but off the lows of the session.
Tuesday’s Federal Reserve meeting will attract less attention than usual as the crisis in Japan deepens. The Fed will release a statement at 2:15 p.m. that will give investors an indication of the Fed's latest views on its economic stimulus program, known as quantitative easing.
Elsewhere in company news, KKR holds an investor day for the first time ever, starting at 8 a.m. on Tuesday.
And Nasdaq is moving closer to a hostile bid for NYSE Euronext , which could come as early as Tuesday, sources close to the matter told CNBC.
In economic news, homebuilder confidence rose for the first time in four months, as the National Association of Home Builders/Wells Fargo Housing Market Index rose to 17 from 16, the highest level since May 2010.
The news lifted shares of some homebuilders, including DR Horton , Lennar and Hovananian .
Also, import prices rose 1.4 percent, the fifth monthly gain, amid rising oil prices, according to the U.S. Labor Department. Economists surveyed by Reuters had expected import prices to rise 0.9 percent. Nasdaq futures fell 2.5 percent.
Also, the New York Fed's Empire State index rose more than expected to 17.5, a nine-month high, from 15.43 the month before, according to the New York Federal Reserve.
In Europe, stocks slid to a 3-and-a-half month lowon investors worries about the effect of the escalating crisis in Japan.
On Tap Next Week:
TUESDAY: Credit card default rates, FOMC meeting announcement.
WEDNESDAY: Mortgage applications, housing starts, producer price index, current account, and oil inventories.
THURSDAY: Consumer price index, jobless claims, industrial production, leading indicators, Philadelphia Fed survey, natural gas inventories, money supply; before-the-bell earnings from FedEx and Lululemon; after-the-bell earnings from Nike.
FRIDAY: Quadruple witching; before-the-bell earnings from Allianz.
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