Stocks suffer setback

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NEW YORK (CNNMoney.com) -- Stocks slumped Tuesday, with a pummeling in bank shares and jitters ahead of a Federal Reserve announcement giving investors a reason to retreat.

The Dow Jones industrial average (INDU) lost 97 points, or 1%. The S&P 500 (SPX) index fell 13 points, or 1.3%. The Nasdaq composite (COMP) dipped 23 points, or 1.1%.

Stocks slipped modestly in the first 30 minutes of the session, but lost more steam as new banking sector woes surfaced and after the government said wholesale inventories fell 1.7% in June versus forecasts for a drop of 0.9%.

Investors were also focusing on the Fed's 2-day meeting, which concludes Wednesday afternoon with the release of a decision on interest rates and a statement on the economy.

"I think there's some apprehension ahead of the Fed," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research. "We know they're going to leave rates alone, but there's some question about what they'll say."

The banking sector retreated after CIT Group (CIT, Fortune 500) delayed its quarterly filing, reviving bankruptcy fears, and several analysts sounded an alarm on the sector. Influential analyst Richard X. Bove of Rochdale Securities said that bank stocks are trading on "fumes" and that investors should take some short-term profits. JPMorgan Chase downgraded bond insurer MBIA (MBI), according to published reports.

Ahead of the Fed meeting, the Commerce Department releases the June trade gap. The trade gap is expected to have widened to $28.5 billion from $26 billion in May, a 10-year low.

The weekly oil inventories report from the Energy Information Administration is also due in the morning. The July Treasury budget is due in the afternoon.

Applied Materials (AMAT, Fortune 500) is likely to be active Wednesday. After the close Tuesday, the chipmaker reported a quarterly loss versus a profit a year ago on weaker revenue. However, the results were better than what analysts were expecting and shares gained 3% in extended-hours trading.

Rally takes a rest: Stocks rallied through the end of last week as part of a broader advance that lifted the S&P 500 over 50% off the March lows. But investors have dragged their feet this week as they look for new signs that the economy is stabilizing.

This week, the two-day Federal Reserve policy meeting and the Treasury auctions will take center stage.

"We don't expect any changes from the Fed," said Tim McCandless, senior equity analyst at Bel Air Investment Advisors. "Eventually they will outline an exit strategy, but not yet."

McCandless said that while stocks are lower so far this week, a rally can probably stretch out through the rest of August, before facing bigger challenges in the fall.

Fiscal stimulus and "less bad" economic news and profit reports fueled the stock market rally so far. But, longer term, "we need to see a shift from stabilization in the economy and cost cutting driving earnings to real growth," he said.

On the move: Stock declines were broad based, with 26 of 30 Dow issues falling.

Dow financial issues American Express (AXP, Fortune 500), Bank of America (BAC, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Travelers Companies (TRV, Fortune 500) all declined. The KBW Bank (BKX) index lost 4.4%.

Among other financial sector movers, CIT Group (CIT, Fortune 500) slumped after saying it will delay filing its quarterly report as it continues to try to restructure its debt and avoid filing for bankruptcy protection.

IBM (IBM, Fortune 500), Cisco Systems (CSCO, Fortune 500), Chevron (CVX, Fortune 500), Caterpillar (CAT, Fortune 500), Walt Disney (DIS, Fortune 500) and General Electric (GE, Fortune 500) were the Dow's other big decliners.

Market breadth was negative. On the New York Stock Exchange, winners beat losers by almost three to two on volume of 1.2 billion shares. On the Nasdaq, advancers topped decliners by over two to one on volume of 1.96 billion shares.

Federal Reserve meeting: The Federal Reserve concludes its two-day meeting Wednesday with an announcement expected at around 2:15 p.m. ET.

The central bank is expected to hold rates steady at historic lows near zero percent.

In its closely scrutinized statement, the bankers are expected to say that economic activity is picking up, but that they remain cautious about the outlook. The bank is not expected to say anything too specific about what its exit strategy may be after putting so much stimulus into the financial system.

Economy: U.S. productivity in the second quarter jumped at the fastest pace in six years, the government said Tuesday. Productivity -- which measures how much workers produce per hour worked -- rose 6.4% versus forecasts for a rise of 5.5%. Productivity rose 0.3% in the first quarter.

Oil and gold: U.S. light crude oil for September delivery fell $1.15 to settle at $69.45 a barrel on the New York Mercantile Exchange.

COMEX gold for December delivery rose 70 cents to settle at $947.60 an ounce.

Bonds: Treasury prices rallied, lowering the yield on the benchmark 10-year note to 3.67% from 3.77% late Monday. Treasury prices and yields move in opposite directions.

The government is offering $75 billion this week as part of its ongoing efforts to reduce the deficit and fuel its recovery efforts.

Investors reacted mildly to the conclusion of the first auction Tuesday. Treasury sold $37 billion in three-year notes and saw stronger demand than in other recent auctions.

On Wednesday, the government auction $23 billion in 10-year notes and on Friday it auctions $15 billion in 30-year bonds.

Other markets: In global trading, European and Asian markets tumbled.

In currency trading, the dollar fell versus the euro and the Japanese yen.