The tech-focused Nasdaq suffered its biggest loss in more than five weeks, while the three main gauges all fell to their lowest levels since Dec. 31, before investors started picking up stocks on hopes of better market prospects for the new year.

"The news today coming from two key bellwethers is taking away some of the recent enthusiasm," said Steven Goldman, chief market strategist at Weeden & Co.

The Dow Jones industrial average declined 111.13, or 1.3 percent, to close at 8,586.74, for a three-day loss of nearly 256 points.

The broader market also finished sharply lower. The Nasdaq composite index dropped 47.56, or 3.3 percent, to 1,376.19, the largest decline since Dec. 9, when it fell 55 points. The Standard & Poor's 500 index fell 12.82, or 1.4 percent, to 901.78.

For the week, the three gauges snapped a two-week winning streak, with the Dow losing 2.3 percent, the Nasdaq declining 4.9 percent, and the S&P 500 falling 2.8 percent.

IBM fell $4.75 to $81.30 after the computer company reported a drop in fourth-quarter profits that nonetheless beat analysts' estimates. However, it also issued a cautious outlook for 2003.

Microsoft dropped $3.89 to $51.46 after the software maker said it would issue its first dividend and reported profits that slightly beat Wall Street's expectations. The company also announced plans for a two-for-one stock split, but said it didn't see signs of improving demand.

"The trend so far is that most of the companies are beating expectations for the fourth quarter, but are talking rather pessimistically for the rest of the year," said Stephen Massocca, president of Pacific Growth Equities.

Analysts attributed the retreat largely to premature optimism about earnings and President Bush's proposal to cut taxes by $674 billion over 10 years, a plan which may turn out to be quite different if it's passed by Congress.

"Earlier in the year, we had a rally based on the feeling that companies will come in better than expected. That did happen, but the problem is that it may not continue," Massocca said.

The mixed earnings news as well as concerns about a war with Iraq have left many investors uncertain, leading to cautious and choppy trading.

Today, Saddam Hussein called on his people to rise up and defend the nation against a new U.S.-led attack and promised that Iraq's enemies would face "suicide" at the gates of his capital.

"Until we start the war, the market will probably be in this limiting capped market, and hopefully once we get a clearer picture of the recovery's strength, stock prices should be poised to move higher afterwards," Goldman said.

A trio of disappointing economic reports also weighed on stocks.

The University of Michigan's mid-month report on consumer sentiment for January fell to 83.7 from 86.7 in December, according to Dow Jones Newswires. The confidence reading fell short of economists' expectations of 86.4.

Meanwhile, the Federal Reserve reported that production in the nation's industrial sector unexpectedly dipped by 0.2 percent in December, more than erasing a 0.1 percent gain the previous month. Analysts had forecast a 0.2 percent increase.