Stocks logged their worst day in a month Monday as a key manufacturing gauge came in weaker than expected and the dollar made a comeback.
The Dow Jones Industrial Average dropped 187.13, or 2.1 percent, to close at 8,612.13. The S&P 500 shed 2.4 percent and the Nasdaq lost 2.3 percent.
The CBOE Volatility Index, widely considered the best gauge of fear in the market, finished at nearly 31. Some analysts said that's a sign of worse things to comefor stocks this summer.
Wall Street had an impressive roll heading into the new week: The Nasdaq has chalked up weekly gains in 13 of the past 14 weeks, while the Dow and the S&P 500 had risen in 12 of the past 14 weeks. All three indexes were positive for the year as of Friday's close and the Dow and S&P were on track for their best quarterly gains since the fourth quarter of 1998.
But weak economic data and the strong dollar threw water on the rally. And after today's losses, the Dow is now down 1.9 percent for the year. The S&P and Nasdaq remain up — 2.3 percent and 15 percent, respectively — for the year.
The New York branch of the Federal Reserve reported its Empire State Manufacturing Index fell to minus-9.41in June from minus-4.55 in May, indicating difficult times in the sector and presenting a headwind for economic growth.
Investors look to the New York report as a precursor to what's to come in the Philly Fed report, due out Thursday, and the national reading from the ISM, due out in two weeks.
And IMF chief Dominique Strauss-Kahn said the worst may be yet to come for the global economic crisis.
One economist said the market's reaction may have been overblown.
"[E]ven when these [manufacturing] indices manage to move in the same direction, the relative magnitude of the changes often varies greatly. We therefore do not think that the Empire index adds any real worth to the economic knowledge base, and it receives more market attention than warranted," Joshua Shapiro, chief U.S. economist at MFR Inc., wrote in a note to clients.
But others said this pullback was to be expected.
"The economy has averted a depression, but it is still shrinking and the stock market has got carried away with all these green shoot discussions," Juerg Zingg of Q Investments told CNBC. “There’s nothing like a rebound here—markets have taken too much optimism as a result we expect market correction,” he said.
The dollar rebounded against major currencies including the euro, yen and pound, after Russia's finance minister said on the sidelines of a gathering of G8 finance ministers in Italy that the dollar's role as the world's primary reserve currency was unlikely to change anytime soon.
And crude oilsettled below $71 a barrel, after trading above $73 last week.
Twenty-eight of 30 Dow stocks finished lower, led by Alcoa , DuPont and Merck.
The two Dow stocks that finished higher were Microsoft and American Express .
For Microsoft, the buzz about Bing continued, like this Tech Crunch piece that explains how Bing outperformed Google in Laker results this weekend. Still, it's going to be tough for Microsoft to translate such rave reviews into market share, given Google's near synonymity with search.
Wal-Mart shed 2.8 percent after Goldman Sachs cut its rating on the stock to "neutral" from "buy," saying it doesn't see a lot of positive catalysts to drive shares higher in the near term amid cost pressures and tough comparisons.
Meanwhile, Goldman added Wal-Mart rival Target to its "conviction buy" list, saying it expects significant earnings momentum for the retailer in the fourth quarter. Target shares slipped 0.7 percent.
Banks finished sharply lower, with Bank of America , Citigroup , JPMorgan and Wells Fargo all down about 3 percent, after the U.S. government revealed that financial institutions may face tougher regulations under new rules designed to avoid another financial crisis.
The administration's regulatory overhaul will get rid of "gaps" in the system that encouraged risky behavior that led to the current meltdown, Treasury Secretary Tim Geithner said.
"We had a financial system that was fundamentally too unstable and fragile, and it did a bad job of basic protection of consumers and investors," Geithner said during an economic summit hosted by Time Warner.
Forbes CEO Steve Forbes told CNBC that the Federal Reserve should stop buying government debt and move its attention to consumer-focused areas of the credit market.
Tech stocks were among the biggest decliners, with the Philadelphia Stock Exchange semiconductor index down nearly 1.6 percent.
Among the day's few gainers were: Visa , Coach , DelMonte and Buffalo Wild Wings .
Trading volume was low, with 1.15 billion shares changing hands on the New York Stock Exchange. Decliners outpaced advancers, roughly 5 to 1.
TUESDAY: Housing starts; PPI; industrial production; Obama hosts South Korean leader to discuss North; Earnings from Best Buy, Smithfield Foods, Adobe
WEDNESDAY: Bernanke speaks; weekly mortgage applications; CPI; crude inventories; Obama to outline plans for financial reform; Earnings from FedEx
THURSDAY: Weekly jobless claims; leading indicators; Philly Fed index; Earnings from Research In Motion
FRIDAY: Quadruple witching
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