Equities opened lower after yesterday's selloff, then fell further when the Institute for Supply Management reported that its non-manufacturing business index, which measures the service sector, dropped to 53.3 in September from 65.0 in August. While any reading above 50 indicates the economy is expanding, the sharp drop in the index was unexpected, following a strong report in manufacturing earlier this month.

Today's reading, which indicated supply managers were worried about higher energy costs, spooked investors already nervous about the effects that rising oil and gas prices will have going forward.

The market was still mulling yesterday's comments from Dallas Federal Reserve Bank President Robert Fisher, who said inflation was nearing the high end of the Fed's comfort zone — a clear signal that the Fed's short-term interest rate hikes would continue. The higher prices for energy have been filtering into the rest of the economy.

Investors are also jittery about earnings season, which officially starts Monday. Some companies such as Clorox Co. have already begun to warn their earnings will not meet expectations.

"We need to get (earnings season) out of the way and see how companies are doing," said Barry Berman, head trader for Robert W. Baird & Co. in Milwaukee.

The Dow Jones industrial average fell 123.75, or 1.19 percent, to 10,317.36. The decline followed a drop of 94.37, or 0.9 percent yesterday.

Broader stock indicators were lower. The Standard & Poor's 500 index fell 18.08, or 1.49 percent, to 1,196.39, and the Nasdaq composite index fell 36.34, or 1.7 percent, to 2,103.02. The major indexes are at their lowest points since the week of July 4.

Small caps, which are highly sensitive to interest rates, dropped sharply. The Russell 2000 index of smaller companies fell 18.86, or 2.84 percent, to 644.98.

A barrel of light crude settled at $62.79, down $1.11, on the New York Mercantile Exchange.

Bonds rose, with the yield on the 10-year Treasury note falling to 4.35 percent from 4.38 percent late yesterday. The U.S. dollar was mixed against other major currencies in European trading. Gold prices fell.

Investors are facing a Wall Street nightmare: A slower economy and higher interest rates.

Those looking for signs of a slowdown are finding them. For instance, home equity lending at banks has slowed from a peak rate of $2 billion to $3 billion a week to "a trickle" of $100 million in the past several weeks, according to a Citigroup report.

"There's just a lot of nervousness and cross currents," Berman said.

One example: Home builder Hovnanian Enterprises Inc. fell $1.09 to $48.19 despite its report that new contracts rose 61.5 percent in September. Investors are concerned that the steep run-up in housing prices is starting to stall as interest rates climb; those fears were compounded by a New York Times report yesterday that insiders in home building companies have sold, in aggregate, almost $1 billion of the companies' stock this year.

Other home builders also dropped. D.R. Horton Inc. fell 84 cents to $34.36; KB Home fell $2.95 to $67.46 and Toll Brothers, Inc. fell 92 cents to $40.48.

Utility operator Entergy Corp. fell $2.21 to $72.21 after it said the damage it suffered from Hurricane Rita will range from $400 million to $550 million, a bill that comes on top of damages that could hit $1.1 billion from Hurricane Katrina. Entergy's New Orleans unit filed for bankruptcy protection after Katrina, citing $325 million to $475 million in damages to power and natural gas transmission systems and the loss of most of its customer base.

Wendy's International Inc. rose 61 cents to $47.33 even though it said third-quarter same-store sales — or sales at stores open at least one year — fell 5 percent at its flagship chain, as high gas prices curbed consumer spending and hurricanes shuttered restaurants. The hamburger chain operator also said the effects of the recent storms and higher beef prices will hurt third-quarter profits, but investors are excited by the planned initial public offering of its Tim Hortons chain.

Declining issues led advancers by more than 5 to 1 on the New York Stock Exchange, where preliminary consolidated volume came to 2.52 billion, up from 2.37 billion traded yesterday.

Overseas, Japan's Nikkei stock average fell 0.36 percent. Britain's FTSE 100 fell 1.21 percent, Germany's DAX index dropped 1.34 percent, and France's CAC-40 fell 1.21 percent.