Bulls throw in the towel

NEW YORK (CNNMoney.com) -- Stocks tanked Friday, as investors abandoned ship after a two-session rally that followed a tough start to the new year.

The Dow Jones industrial average (INDU) lost 1.4 percent, according to early tallies. The broader Standard & Poor's 500 (SPX) index lost 1.6 percent, and the Nasdaq composite (COMP) lost 1.5 percent.

Stocks rallied through the morning as investors looked to extend the rally, thanks to Microsoft's earnings and outlook. But the tone turned negative in the afternoon, with financials leading the downturn.

Treasury prices rallied, lowering the corresponding yields as investors again sought safety in government debt, as they had earlier in the week.

The market action this week suggests that the stock market is trying to find a floor to bounce off of. However, that process can be volatile for a bit before stocks start moving higher again.

"The market touched what might have been an intermediate-term bottom earlier this week and it may may retouch it over the next five or 10 trading days," said John Merrill, chief investment officer at Tanglewood Capital Partners.

Wall Streeters want the market to stabilize, he said, but that process is being drawn out since there is still so much negativity and fear in the market

Late Thursday, Microsoft (MSFT, Fortune 500) reported higher quarterly revenue and profit that topped estimates in its fiscal second quarter. The software leader also forecast higher sales and earnings for the next two quarters and 2008 fiscal year.

Shares of the Dow component initially jumped 3 percent, propelling the technology sector, before giving up those gains and turning lower, dragging the tech sector along with it.

A tough start to the year. Stocks have tumbled through most of January on worries that housing and credit market woes will send the economy into a recession, if it isn't there already.

Such worries were evident Friday, with the market first pulling back on rumors of more writedowns at big European banks and troubles for a major hedge fund, traders said.

News that Goldman Sachs (GS, Fortune 500) is cutting 5 percent of its global workforce added to weakness, since Goldman is one of the few big banks that hasn't seen a significant subprime hit. However, the company said it was a standard annual move of dismissing the worst performers following company reviews.

"We've had a couple of pretty good days and so it's not surprising to see us losing a little steam here," said Ron Kiddoo, chief investment officer at Cozad Asset Management.

Kiddoo said day-to-day trading is going to remain volatile as Wall Street continues to try to get a handle on the long-term impact from the subprime fallout.

Investors got some relief this week. Supportive factors included the Federal Reserve's emergency interest rate cut, talk of a bond insurer bailout and a deal that was struck on a $150 billion fiscal stimulus package that will yield tax rebates for millions of Americans.

Earnings. In addition to Microsoft, fellow Dow component Honeywell (HON, Fortune 500) reported higher quarterly profit that met expectations and also forecast continued growth in 2008, despite the weakening economy. Caterpillar (CAT, Fortune 500), also a Dow component, reported higher earnings that met forecasts as well.

Ambac Financial (ABK) rallied on reports that billionaire Wilbur Ross is in serious talks to buy the troubled bond insurer, although broader relief for the sector could take some time, New York regulators said Friday.

Late Thursday, Amgen (AMGN, Fortune 500) reported higher earnings and weaker sales in the fourth quarter, both above analysts' expectations.

Market breadth turned negative. On the New York Stock Exchange, losers beat winners by almost 3 to 2 on volume of nearly 1.1 billion shares. On the Nasdaq, decliners narrowly edged advancers on volume of 1.72 billion shares.

Other markets. In global trade, European markets ended mostly lower, while Asian markets posted big gains.

Treasury prices rallied, lowering the yield on the 10-year note to 3.59 percent from 3.71 percent late Thursday. Bond prices and yields move in opposite directions.

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

U.S. light crude oil for March delivery rose $1.30 to $90.71 a barrel on the New York Mercantile Exchange.

COMEX gold rallied $4.90 to $910.70 an ounce.