Investors backed away from stocks amid growing concerns that consumer spending will wane this year and contribute to an economic downturn. The latest evidence that consumers are retrenching came from the Commerce Department, which said retail sales fell in December and which also revised its November figures lower. Spending by consumers, which accounts for more than two-thirds of U.S. economic activity, has been key to staving off economic slowdowns in recent years.

There is also a growing fear that the Federal Reserve hasn't done enough to keep the economy going — especially as investors continue to see the fallout from the summer's subprime mortgage crisis. Citigroup, the nation's biggest bank, announced on Tuesday a hefty $18.1 billion write-down for bad mortgage assets and slashed its dividend.

Brian Gendreau, investment strategist for ING Investment Management, said the market is now seeing "a decisive shift" toward a recession.

"The sectors that are outperforming are defensive plays, like consumer staples," he said. "People don't buy them unless you're worried about sustained weakness."

Investors have sold stocks lower so far this year on increasing worries about the economy. According to preliminary calculations, the Dow fell 277.04, or 2.17 percent, to 12,501.11.

Broader stock indicators also lost ground. The Standard & Poor's 500 index dropped 35.30, or 2.49 percent, to 1,380.95, and the Nasdaq composite index lost 60.71, or 2.45 percent, closing at 2,417.59.

Declining issues outnumbered advancers by about 3 to 1 on the New York Stock Exchange, where volume came to 1.53 billion shares.

Bond price rose. The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 3.69 percent, close to its lowest point since March 2004 and down from 3.77 percent late Monday. The dollar was mixed against other major currencies, while gold prices rose.

Light, sweet crude fell $2.30 to settle at $91.90 per barrel on the New York Mercantile Exchange.

Tuesday's trading, which more than wiped out Monday's triple-digit gain in the Dow, showed the depths of the market's pessimism amid increasing signs that the economy is weakening. Many investors, heeding warnings of some economists, fear the country is headed toward recession, and a stream of disappointing economic data like Tuesday's retail sales data is reinforcing those fears.

In just the 10 trading days of 2008, the Dow has fallen 5.76 percent, while the S&P 500 is down 5.95 percent and the Nasdaq has lost 8.85 percent.

"When consumers are beaten over the head about how bad things are, pretty soon they believe it and that affects their spending habits," said Scott Wren, equity strategist for A.G. Edwards & Sons. "And when there's a lot of uncertainty out there, the Fed needs to be a little more aggressive — I think they need to cut more than just at this next meeting."

Still, hopes for a rate cut weren't enough to calm Wall Street.

He said the worrisome fall in retail sales, which also pressures the dollar, builds a case that the cut will be at least 0.50 percentage point. It also increases the likelihood of further cuts after the central bank's Jan. 29-30 meeting.

Adding to investors' concerns, the New York Federal Reserve's Empire State survey of regional manufacturing showed a drop to 9.03 this month from 9.80 in December.

But there was some relief about inflation. Producer prices fell 0.1 percent, according to the Labor Department. The result was smaller than the 0.2 percent drop expected by economists, but all declines in price pressure are generally good news. Excluding food and energy, producer prices gained 0.2 percent, matching expectations.

Financial services stocks were among the biggest influences on investors during Tuesday's session. Citigroup's drastic efforts to shore up its balance sheet had been widely expected, but it still was a forceful reminder of the serious problems that bad lending practices have created for financial services firms.

Citigroup, which lost $9.83 billion in the fourth quarter, also announced a massive $12.5 billion capital injection. Hope that struggling financial firms will bolster their finances also was stirred by news that Merrill Lynch & Co. Inc. agreed that three foreign investment funds will invest $6.6 billion in the Wall Street firm.

Citi fell $2.21, or 7.6 percent, to $26.85. Merrill — which reports results on Thursday — fell $2.96, or 5.3 percent, to $53.01.

The Russell 2000 index of smaller companies fell 15.05, or 2.11 percent, to 697.43.