Wall Street plunged today, driving the Dow Jones industrials down 370 points after investors saw an unexpected contraction in the service...

Share story

NEW YORK — Wall Street plunged today, driving the Dow Jones industrials down 370 points after investors saw an unexpected contraction in the service sector as evidence the economy is sinking into recession. It was the Dow’s biggest point drop since last August.

The Dow fell 370.03, or 2.9 percent, to 12,265.13, the blue-chip index’s largest one-day point drop since it fell 387 points on Aug. 9, 2007.

Microsoft, one of the 30 Dow stocks, fell $1.12 to close at $29.07. Boeing, also a Dow stock, fell $1.21 to $81.69.

The broader Standard & Poor’s 500 index lost 44.18, or 3.2 percent, closing at 1,336.64, while the Nasdaq composite index lost 73.28, or 3.1 percent, to 2,309.57.

In Monday and today’s trading, the Dow gave up the gains it made last week, when it jumped 4.39 percent. It’s not surprising that the volatile market would pull back; some analysts claim stocks should be near their bottom given how low investor sentiment is right now.

Bond prices jumped as investors sought the safety of government-backed debt. The yield on the benchmark 10-year Treasury note, which moves opposite its price, sank to 3.58 percent from 3.64 percent late Monday.

The volatility that pummeled stocks in January returned with the news that the service sector shrank last month for the first time since March 2003. The report from the Institute for Supply Management (ISM) wiped out the nascent optimism about the economy that had sent stocks surging higher last week.

“The report drives a nail into the coffin from investors’ minds that we’re in a recession,” said Todd Salamone, director of trading at Schaeffer’s Investment Research. “That doesn’t mean stock prices in the months ahead will be lower. But when you see headline numbers like this, there tends to be a reactionary sell.”

The ISM said its index of service sector activity, which accounts for about two-thirds of the economy, dropped below 50, a level that indicates contraction. Economists had expected another month of growth.

It’s possible the service sector, which includes businesses ranging from restaurants to retailers to banks, could bounce back in February as the manufacturing sector did in January after its December contraction. The benefit of the Federal Reserve’s two big interest rate cuts in the latter part of January could also help spur the service sector back into growth mode later this year.

Still, the data was particularly worrisome given last week’s Labor Department report, which showed that the U.S. economy lost jobs in January for the first time in more than four years. Together, the two reports indicate that the ongoing credit crisis is dragging down the actual economy.

Fitch Ratings’ plans to lower the rating on more than $100 billion wrapped up in bond funds called collateralized debt obligations added to the host of concerns plaguing Wall Street. Further downgrades would mean the securities — many of which are backed by mortgages — are worth even less than many investors thought. That could cause more problems for struggling banks, brokerages, and bond insurers.

According to JPMorgan equities analyst Thomas J. Lee, the three worst readings on record in the ISM’s service sector index are associated with stocks rising in the ensuing three months — on average, by 6 percent.

The biggest losers in the stock market today were banks, which already suffered huge losses in their investment portfolios last year and are now socking billions of dollars away to prepare for debt-burdened consumers to stop making payments.