Escalating tension in the Middle East carried oil near $77 a barrel, which compounded worries over Merrill Lynch's warning that higher lending rates and gasoline prices would likely pressure consumer spending at Wal-Mart Stores Inc. SAP AG rattled investors further after reporting weak software sales last quarter.

Many on Wall Street worried that the day's headlines signaled a worst-case scenario. Continued gains in energy prices could prompt the Federal Reserve to keep lifting interest rates to contain inflation, but the recent spate of downbeat earnings news suggested that economic growth was already moderating. Investors fear higher rates in a cooling economy could lead to a recession.

"At this point in the cycle, you have questions about how much inflation is rising, what the Fed will do and how much growth will slow," said Scott Wren, senior equity strategist at A.G. Edwards & Sons. "That's a debate that's going to be worked out over time. If you're going to buy stocks, you have to take a stance" on where those numbers are headed.

According to preliminary calculations, the Dow slid 166.89, or 1.52 percent, to 10,846.29. Yesterday, the blue-chip index sank 121 points.

Broader stock indicators declined. The Standard & Poor's 500 index lost 16.31, or 1.3 percent, to 1,242.29; the Nasdaq composite index dropped 36.13, or 1.73 percent, to 2,054.11, its lowest level since last October.

Declining issues led advancers by more than 3 to 1 on the New York Stock Exchange.

Bonds edged higher, with the yield on the 10-year Treasury note dropping to 5.08 percent from 5.1 percent late yesterday. The U.S. dollar fell against the Japanese yen; gold prices climbed to about $660 an ounce.

Crude futures soared to a new record close amid new Israeli attacks on Lebanese bases and Iran's hard-line stance on its nuclear program. A barrel of light crude gained $1.75 to settle at $76.70 on the New York Mercantile Exchange.

Although consumers and businesses have so far appeared to weather the persistently high price of oil, an uneasy start to second-quarter earnings has investors nervous about a potential downturn in the economy. Analysts, however, have insisted that the economy remains sturdy and that the market's pessimism is overdone.

"There is definitely negative momentum to the news," said Philip Dow, managing director of equity strategy at RBC Dain Rauscher. "It makes people believe we are genuinely headed for a bear market. But we have to have a bad economy for that to happen, and I don't think we have one."

Manufacturing conglomerate General Electric Co. releases its earnings tomorrow morning, but Dow said a strong report might not be enough to counter worry about the Middle East conflict and boost stocks. "My bet is when all is said and done, we'll have a much more balanced reaction to the second quarter," Dow said.

In economic news, the Labor Department said the number of first-time applications for jobless benefits rose 19,000 to 332,000 last week, a possible sign of an impending slowdown in the economy. Analysts had forecast a 7,000 increase.

SAP said second-quarter software sales grew 8 percent to $790 million, missing forecasts for 17 percent growth to $858.7 million. SAP tumbled $3.51 to $46.83, helping tech stocks to a second day of steep losses.

PepsiCo Inc., the No. 2 soft-drink company, said sales of non-carbonated beverages lifted its second-quarter profit by 14 percent to top Wall Street estimates. PepsiCo rose 97 cents to $62.07.

Tribune Co. lost 85 cents to $31.50 after the newspaper publisher posted a lower quarterly profit. Revenue slid 1 percent as circulation and television ad sales declined.

British insurance company Aviva PLC agreed to acquire U.S. insurer AmerUs Group Co. for $69 per share, or $2.9 billion. AmerUs rose 31 cents to $66.81.

Dow component Walt Disney Co. sagged $1.21 to $28.70. CIBC World Markets downgraded the media and entertainment conglomerate on concerns about its high stock price and a potential slowdown in 2007.

Merrill Lynch downgraded Wal-Mart one notch to "neutral." Wal-Mart lost 99 cents to $44.16.

Wall Street's yesterday decline pulled down overseas markets. Japan's Nikkei stock average slid 0.99 percent; Britain's FTSE 100 dropped 1.63 percent, Germany's DAX index slumped 1.96 percent and France's CAC-40 was lower by 1.81 percent.

On the NYSE, volume of 1.78 billion shares topped the 1.49 billion shares that changed hands yesterday.

The Russell 2000 index of smaller companies declined 13.88, or 1.98 percent, to 687.29.