Stocks Start Year in Retreat

"Overall, this is a seriously weak report, though the headline is still not quite at recession levels," he said. "We thought that the small rebound in December auto output would be enough modestly to lift the index, so this is very disappointing news. But it is far too close for comfort, and it reinforces our view that the Fed has a lot more easing to do."

U.S. Treasury prices were rallying after the ISM report. The 10-year note jumped 31/32, dropping the yield to 3.91%. The 30-year bond rose 1-25/32 in price, yielding 4.35%.

Record oil and surging gold prices also weighed on sentiment. Crude oil touched the psychologically important $100-a-barrel level for the first time ever, before finishing up $3.64 at $99.62 a barrel. Gold futures jumped $22.10 to $857 an ounce, and silver rose 37 cents at $15.22 an ounce.

Among subsector indices, the Philadelphia Oil Service Sector Index added 2.1%, and the Amex Gold Bugs Index soared 6.3%.

Stocks initially pared losses before dropping again following in the minutes from the Dec. 11 Federal Open Market Committee policy meeting. At that gathering, the central bank cut the fed funds rate by 25 basis points to 4.25%, the third straight reduction. The Fed cited higher energy prices as the potential catalyst for inflation, but also pointed out softening in business and consumer spending and strains in financial markets.

The minutes, released at 2 p.m. EST, said that while the Fed agreed that the stance of policy should be eased, members of the FOMC also believed that the situation was "quite fluid and the economic outlook unusually uncertain.

"Financial stresses could increase further, intensifying the contraction in housing markets and restraining other forms of spending," the minutes read. "Some members noted the risk of an unfavorable feedback loop in which credit market conditions restrained economic growth further, leading to additional tightening of credit; such an adverse development could require a substantial further easing of policy."

Boston Fed Present Eric Rosengren was the lone dissenter during the policy vote as he regarded the weakness in the incoming economic data and in the outlook for the economy as "warranting a more aggressive policy response."

Also on the economic docket, the Commerce Department said construction spending unexpectedly rose 0.1% in November, compared with forecasts of a 0.5% decline.

Last time out, the U.S. market ended a wild year to the downside, with stocks sliding in a lightly traded session. The Dow fell 101.05 points, or 0.76%, to 13,264.82. The S&P 500 lost 10.13 points, or 0.69%, to 1468.36, and the Nasdaq dropped 22.18 points, or 0.83%, to 2652.28.

For all of 2007, the Dow gained 6.4% and the S&P 500 rose 3.5%, but both were hampered by weak a fourth-quarter performance. The Nasdaq was the best big index, climbing 9.8%.

Marc Pado, U.S. market strategist with Cantor Fitzgerald, said that while the year ended on a sluggish note, it was still a strong one for the major averages.