Wall Street worried that the Labor Department's productivity data, which showed a 2.4 percent jump in unit labor costs, was a harbinger of inflation, since that meant companies were paying more for less productive workers. With the Federal Reserve clearly willing to keep raising interest rates to fight inflation, investors worried about the potential economic damage of such a rate hike.

Stocks took a sharp dive early in the session after a number of floor traders said a rumor circulated that the Homeland Security Department was going to announce a new terror threat. Although the rumor proved false, the major indexes had already fallen too much to mount a rally, as concerns about Iran's nuclear program and instability in the Middle East grew.

"I think the market here is in a very nervous state," said Peter Cardillo, chief strategist and senior vice president at S.W. Bach & Co. "You have geopolitical problems surrounding the Iranian situation heating up, and you have concerns about productivity, and that's keeping investors very cautious."

According to preliminary calculations, the Dow fell 101.97, or 0.93 percent, to 10,851.98.

Broader stock indicators also fell sharply. The Standard & Poor's 500 index slid 11.62, or 0.91 percent, to 1,270.84, and the Nasdaq composite index dropped 28.99, or 1.25 percent, to 2,281.57.

Bonds were little changed, with the yield on the 10-year Treasury note steady at 4.56 percent from late yesterday. The yield on the two-year note, however, moved up to 4.57 percent, causing the latest inversion of the Treasury yield curve. When short-term bonds yield more than long-term, investors take that as a sign of a lack of short-term confidence and an omen of future economic disruption.

The U.S. dollar was mixed against other major currencies, while gold prices rose.

Despite the concerns over Iran, oil prices fell as world leaders sought to minimize the chance of substantial conflict there. A barrel of light crude settled at $64.68, down $1.88, on the New York Mercantile Exchange.

A drop in initial jobless claims failed to spark much enthusiasm. The number of first-time jobless claims dropped by 11,000 last week to 273,000. The four-week moving average of claims fell to its lowest level in 5› years, the Labor Department said.

With the Labor Department's monthly jobs report due tomorrow, however, investors were more inclined to remain cautious than to celebrate the news. Should job creation boom, that would raise concerns about inflation, while if job growth is anemic, the Fed's rate hikes could harm an already-slowing economy.

"You can have all the good jobs data, all the good economic data you want, but until the Fed gets out of the way, there just isn't really a whole lot of hope for the stock market to move higher," said Joe Keating, chief investment officer at First American Asset Management in Birmingham, Ala.

Retail stocks were little changed despite strong sales reports for January, as investors had already bid them higher earlier in the week in anticipation of good news. Wal-Mart Stores Inc. led the raft of retail sales announcements with a 4.7 percent increase in same-store sales, or sales in stores open at least a year, for its best performance since May 2004. Analysts had expected 4.4 percent sales growth. Wal-Mart rose 14 cents to $46.28.

Rival Target Corp. added 49 cents to $55.23 after it too beat Wall Street's sales forecasts. Department store chains Nordstrom Inc., which added 13 to $42.13, and J.C. Penney Co. Inc., which climbed 9 cents to $56.06, also exceeded expectations.

In earnings news, Tyco International Ltd. fell $1.30 to $24.80 after its quarterly profits fell 22 percent, due in part to one-time charges related to discontinued operations.

Declining issues outnumbered advancers by nearly 8 to 3 on the New York Stock Exchange, where volume came to 1.91 billion shares, compared with 1.93 billion traded yesterday.

The Russell 2000 index of smaller companies fell 9.23, or 1.26 percent, to 726.25.

Overseas, Japan's Nikkei stock average surged 1.4 percent. European stocks mirrored Wall Street's sharp decline. Britain's FTSE 100 closed down 0.94 percent, France's CAC-40 lost 1.43 percent for the session, and Germany's DAX index fell 1.34 percent.