The Labor Department's producer price index fell 1.4 percent, the sharpest decline in three years. However, so-called core PPI, with volatile food and fuel prices removed, rose 0.3 percent, slightly higher than Wall Street expected.

Investors are worried that higher core inflation could mean more interest rate hikes from the Fed. A speech from Fed Chairman Ben Bernanke Monday night did little to calm those fears, as the new Fed chairman gave no sign whether monetary policy makers would continue raising rates.

"To me, you have the PPI number showing some slippage in the core rate, which raises some questions on inflation," said Joseph Battipaglia, chief investment officer at Ryan Beck & Co. "There was nothing in Bernanke's comments that were unsettling, but no real signals, either."

Stocks had rallied into positive territory around midday, but fell sharply after the major indexes touched upon new five-year highs — apparently prompting investors to take profits, especially with the Fed meeting still to come next week.

According to preliminary calculations, the Dow Jones industrial average fell 39.06, or 0.35 percent, to 11,235.47.

Broader stock indicators also fell. The Standard & Poor's 500 index lost 7.85, or 0.6 percent, to 1,297.23, and the tech-focused Nasdaq composite index dropped 19.88, or 0.86 percent, to 2,294.23.

Bonds moved sharply lower, with the yield on the benchmark Treasury note rising to 4.72 percent from 4.66 percent late Monday. The dollar rose against most major currencies, while gold prices fell.

Crude prices rose modestly after dropping $2.35 per barrel in the previous session. A barrel of light crude settled at $60.57, up 15 cents, on the New York Mercantile Exchange.

The tech sector was particularly volatile as investors reacted to a tepid earnings report from Oracle Corp. late Monday. While the company's quarterly earnings were a penny better than Wall Street forecasts, investors were concerned about slipping licensing revenue. Oracle started lower, then led the midday rally in tech before fininshing 10 cents lower at $13.62.

"I think the market bounced off of Oracle's turnaround, which triggered some institutional buying," said Brian Williamson, an equity trader at The Boston Company Asset Management. "We had some momentum buying that lifted tech, but the rest of the market kind of faded off."

Elsewhere in the tech sector, Rambus Inc. rose $1.82, or 5.3 percent, to $36.22 after the microchip technology licensing company increased its first-quarter revenue outlook.

Target Corp. tightened its March sales forecasts, now expecting sales to rise between 1.5 percent and 2.5 percent. The retailer originally predicted sales increases between 1 percent and 3 percent. Target slipped 17 cents to $53.36.

Bally Total Fitness Holding Corp. surged $1.15, or 15 percent, to $8.99 after The New York Post reported Britain's Virgin Group was considering a takeover of the fitness chain.

Citigroup Inc. announced that Chief Executive Charles Prince would succeed Sanford I. Weill as chairman when the latter officially retires at the company's April 18 annual meeting. Prince will retain the CEO title. Citigroup fell 18 cents to $47.22.

Declining issues outnumbered advancers by nearly 8 to 3 on the New York Stock Exchange, where volume came to 1.58 billion shares, compared with 1.42 billion traded at the same point Monday.

The Russell 2000 index of smaller companies fell 9.52, or 1.28 percent, to 736.10.