The S&P 500 slid to its lowest level since late July on Wednesday, driven by uncertainty over US budget negotiations and an escalation of violence in the Middle East.
US President Barack Obama, in his first press conference since re-election, held to his position that marginal tax rates will have to rise to tackle the nation's deficits. With talks over solving the U.S. "fiscal cliff" in early stages, investors are reacting to the uncertainty by shedding positions.
"I think we will have a last-minute cliffhanger solution," said Michael Cheah, portfolio manager at SunAmerica Asset Management in Jersey City, New Jersey, about a deal to avoid the so-called cliff.
"In the meantime, the market is going to get punched every day."
Without a deal, a series of mandated tax hikes and spending cuts will start to take effect early next year that could push the US economy into a recession.
Taxes on capital gains and dividends could rise as part of the negotiations, pushing investors to sell this year and pay lower taxes on their gains.
Buying interest has been weak in the stock market of late, as brief early market rallies have succumbed to selling pressure.
Adding to the selling pressure, Israel launched a major offensive against Palestinian militants in Gaza, killing the military commander of Hamas in an air strike and threatening an invasion of the enclave. Egypt said it recalled its ambassador from Israel in response.
"We know Europe's in trouble, China's slowing down ... and now you've got the Middle East flaring up again. It's all hitting at once, and obviously, the market is taking a 'sell first, ask questions later' approach," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati.
Industrial shares led the decline, dragged lower in part by a 1 per cent spike in crude prices after the Israeli offensive on Gaza. The S&P industrial sector index fell 2.5 per cent.
Wall Street had opened higher after Dow component Cisco Systems reported first-quarter earnings and revenue late Tuesday that beat expectations, driving its stock up 4.8 per cent to $US17.66. But the positive momentum was short-lived.
The Dow Jones industrial average fell 185.23 points, or 1.45 per cent, to 12,570.95 at the close. The S&P 500 dropped 19.04 points, or 1.39 per cent, to 1,355.49. The Nasdaq Composite lost 37.08 points, or 1.29 per cent, to 2,846.81.
Both the Dow industrials and the Nasdaq ended at their lowest levels since late June.
The S&P 500 closed below its 200-day moving average for a fifth day in a row, a technical indicator that suggests recent declines are gaining momentum. It was the benchmark S&P 500's lowest close since July 25.
The Russell 2000 tumbled 2 per cent and the Dow Jones Transportation average slid 2.6 per cent. FedEx Corp shares dropped 3.7 per cent to $US87.12. Bank of America shares lost 3.6 per cent to $US8.99.
In contrast, Facebook shares jumped 12.6 per cent to $US22.36 as investors were relieved that expiring trading restrictions on a huge block of shares did not trigger an immediate wave of insider selling.
Teen clothing retailer Abercrombie & Fitch jumped 34.4 per cent to $US41.92 after the company reported unexpectedly improved third-quarter results and a full-year outlook that exceeded Wall Street's forecasts.
About 7.4 billion shares changed hands on the New York Stock Exchange, the Nasdaq and NYSE MKT, more than the daily average so far this year of about 6.51 billion shares.
On the NYSE, decliners outnumbered advancers by a ratio of almost 9 to 1. On the Nasdaq, about four stocks fell for every one that rose.