Wall Street's worst day in 3 months

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NEW YORK (CNNMoney.com) -- Stocks tanked Tuesday, after a report showing a big slowdown in the services sector of the economy and cautionary comments from a Fed official amplified fears that a recession is underway or imminent.

The Dow Jones industrial average (INDU) lost about 370 points, seeing its worst one-day point loss since mid-October. The decline equaled a drop of 2.9%.

The broader Standard & Poor's 500 (SPX) index lost 44 points, its worst single-day point loss in almost 6 months. The decline equaled a drop of 3.2%.

The Nasdaq composite (COMP) fell 73 points and saw its worst single-day point loss since mid-October. The decline equaled a drop of 2.6%.

"The pebble in the pond this morning was the ISM report and then the comments from [Fed President] Lacker came out and that kind of pushed people over the edge," said Kim Caughey, senior equity analyst at Fort Pitt Capital Partners.

"This is a very volatile time, everyone is nervous and the volatility shows the degree of nervousness," Caughey added.

Stocks tumbled in January, with the Nasdaq seeing its worst start to the year ever, on fears that the credit and housing market crises will send the economy into recession, if it isn't there already.

After such a steep decline, stocks managed to bounce back for a few days last week as investors scooped up battered shares. But the rally was short-lived, with stocks erasing last week's gains in a matter of two sessions.

The speed of the retreat added to investor jitters, said Peter Dunay, investment strategist at Leeb Capital Management. "If we lost that much over three weeks, investors would have seen it as a period of consolidation, but to drop 370 points in a day is really rattling."

After the close, Dow component Walt Disney (DIS, Fortune 500) reported lower quarterly earnings and higher revenue, both of which topped analysts' average forecasts. Shares jumped more than 5 percent after the close. Companies due to report quarterly results Wednesday morning include Biogen Idec (BIIB), Sara Lee (SLE, Fortune 500), Devon Energy (DVN, Fortune 500) and Time Warner (TWX, Fortune 500), CNNMoney.com's parent.

Investors on Wednesday will also be looking at the results of Super Tuesday. (For CNN's primary coverage, click here.)

More hints of a recession. The ISM services index, a survey of services sector executives, showed business activity falling in January for the first time in five years. The report was released nearly an hour ahead of schedule, unnerving investors at the start of trade. The report countered last week's reading on the manufacturing sector, which showed expansion. (Full Story).

"This is the most unequivocal sign we've had that the economy is weakening," said Stephen Stanley, chief economist at RBS Greenwich Capital. "We've had data pointing in that direction, but they've been all over the map and it always seemed like there was a silver lining in the weak reports."

"There is nothing in this report that was redeeming," he added. "It's simply terrible."

Looking to the Federal Reserve. Richmond Fed President Jeffrey Lacker, in a speech Tuesday, said that the report raises the risks of a recession, Briefing.com reported. However, he said that inflationary pressures are also rising, which could limit further interest rate cuts. Lacker is an alternate member of the Fed's policy committee this year.

His comments seemed to suggest the threat of "stagflation," the combination of slowing growth paired with higher inflation, a miserable economic development investors are hoping to avoid.

Last week's monthly jobless claims report and fourth-quarter GDP growth report suggested an acceleration of the economic slowdown. Investors will next look to Wednesday's fourth-quarter productivity report to see if it shows a rise in unit labor costs, i.e. wage inflation, and next week's January retail sales report, amid fears about a consumer spending recession.

The Federal Reserve cut interest rates twice in late January, leaving the fed funds rate, a key short-term interest rate that affects consumer loans, at 3%. The fed also cut the discount rate, which affects bank loans. The Fed has also injected billions into the financial system through a series of auctions.

The Fed actions have already started to have an impact, but it typically takes a good six to 12 months for rate cuts to work their way through the economy.

Stocks on the move. The stock selloff was decisive, with all 30 Dow components sliding, led by financial stocks Citigroup (C, Fortune 500), American Express (AXP, Fortune 500), AIG (AIG, Fortune 500) and JP Morgan Chase (JPM, Fortune 500).

Economically sensitive shares, such as Alcoa (AA, Fortune 500) and Caterpillar (CAT, Fortune 500), slumped too.

Tech declines were also broad, with 95 of the Nasdaq's 100 largest non-financial stocks falling, including Microsoft (MSFT, Fortune 500), Intel (INTC, Fortune 500), Oracle (ORCL, Fortune 500) and Dell (DELL, Fortune 500).

In other corporate news, News Corp. (NWS, Fortune 500) reported higher quarterly earnings that met estimates late Monday. Shares were little changed Tuesday.

Market breadth was negative. On the New York Stock Exchange, losers trounced winners over 4 to 1 on volume of 1.68 billion shares. On the Nasdaq, losers beat winners by more than 3 to 1 on volume of 2.51 billion shares.

Other markets. Treasury prices rallied, as investors sought safety in government debt, lowering the yield on the benchmark 10-year note to 3.56% from 3.64% late Monday. Bond prices and yields move in opposite directions.

In currency trading, the dollar gained versus the yen and the euro.

U.S. light crude oil for March delivery fell $1.61 to $88.41 a barrel on the New York Mercantile Exchange.

COMEX gold for April delivery plunged $19.10 to $890.30 an ounce.