Wall Street had a predictable reaction to the first significant setbacks of "Operation Iraqi Freedom." A growing realization that bringing about "regime change" in Iraq won't be quick, easy or without allied casualties sparked a sharp and substantial selloff Monday.

The

Dow Jones Industrial Average

fell 3.6% to 8214.58, the

S&P 500

lost 3.5% to 864.23 and the

Nasdaq Composite

shed 3.7% to 1369.80. The percentage declines were the largest of 2003 for major averages.

Trends in other markets also reversed the course established by last week's initial military successes. The price of the 10-year Treasury note jumped 1 4/32 to 101.03, its yield falling to 3.96%, while crude futures rose 6.5% to $28.66 per barrel and gold was higher by 1% to $329.50 per ounce. The U.S. Dollar Index fell 0.97 to 101.03.

"Everybody was excited last week as far as the way

the war was going, but the sobering news brought us back to reality," said Scott Curtis, head of U.S. equity trading at Credit Lyonnais. "Unfortunately, this is not

Star Wars

games on a computer."

The stock market's retreat was broad-based, although overall volume was down from last week's levels, especially Friday's, reflecting an absence of panic. "The first couple of hundred points were pretty quick, then we drifted," Curtis said. "The market attempted to rally but couldn't make it."

Still, declining stocks bested advancers 25 to 7 in

Big Board

trading, where down volume was almost 94% of the 1.3 billion total. Losers led 23 to 7 in over-the-counter activity, where down volume was 87% of the 1 billion total. (For those who've inquired, volume is only half of the requirement for a so-called 90% down day, as measured by Lowry's Reports. They usually don't make a determination on the other half -- the price movement of every stock -- until the next day.)

While news from Iraq overwhelmed everything else, Curtis noted that Monday saw the initiation of new contracts after Friday's triple-witching expiration. The amount of open interest in equity options greatly contributed to last week's rally, "although everyone was talking about war," the trader said.

Following

last week's robust gains, some setback for major averages was likely, even expected. But any "natural" retracement was exacerbated by a series of developments over the weekend, including Iraqi counterattacks producing the first major allied casualties and American prisoners, a fragging incident in the 101st Airborne Division in Kuwait, and an accidental shooting of a British warplane by U.S. Patriot missiles.

Reports of Iraqi military "faking" surrender and, aided by "irregular" forces, attacking allied positions, as well as the apparent execution and clear mistreatment of American POWs, the latter televised by al-Jazeera, greatly added to Wall Street and America's unease.

Such feelings intensified Monday as British Prime Minister Tony Blair spoke of a "critical moment" as allied forces approached Karbala, about 60 miles south of Baghdad. There, coalition forces are expected to encounter Republican Guard units that Blair said "are those closest to Saddam that are resisting and will resist strongly." (There has been "no direct firefight" with Republican Guard forces yet, the Pentagon reported in a news briefing at about 3:45 p.m. EST.)

Iraqi television showed what appeared to be a downed U.S. Apache attack helicopter near Karbala on Monday, and the Pentagon confirmed the downing of one Apache in the aforementioned briefing. Earlier in the day, Saddam Hussein appeared on Iraqi television -- reportedly looking in better health than last week -- to rally Iraqi's military against coalition forces.

"After they underestimated you, you Iraqis, now they've come on land; this attempt is our chance to incur losses on them," Hussein said in what was widely agreed was a taped address.

Despite ongoing progress in the broader war, such developments deflated last week's optimism that Hussein's regime was crumbling and that Iraqi resistance would be minimal. The result was a steady setback for stocks Monday, action which bolstered those skeptical of the rally to begin with.

"Last week was something,

but I think what we have is a bear-market rally that was very violent and I think we're probably done with 75% to 80% of it," said Steve Hochberg, chief market analyst at Elliott Wave International in Atlanta. "There was enough upward momentum that you need another week or two trying to form a top, but I don't see anything to suggest a kickoff to a new bull market."

Hochberg noted market breadth was weaker last week than at the October lows, and the 10-day equity put/call ratio had fallen to around 0.72 heading into Monday's session. "There's nothing here to suggest we're ready to blast off." (The put/call ratio settled at 0.85 on Monday.)

The analyst also noted the myriad differences between the current environment and 1991. "It's not comparable," he said, citing a discussion of the 1991/2003 comparison in the current issue of

Barron's

, an analogy this column explored

March 5.

Gold Still Tarnished

Hopefully, faithful readers will recall this column's early efforts on the "it's not 1991" story.

Similarly, readers also may recall a decidedly bearish call on gold by Hochberg in

early 2003, which he reiterated on Feb. 4, a day before the metal's near-term top.

"The final leg moved beyond what we thought

would happen but gold is basically moving in line with our anticipation," he said Monday. "The trend has turned and

gold has topped."

To recall, Hochberg believes in the very long-term case for gold, as part of a broader concern about global deflation and general bearishness on financial assets. But "in terms of Elliott Wave, it looks like we need gold to go down first

to as low as $200 per ounce and then have a huge rally," he said.

There is "thick support" for gold in the $300 to $320 per ounce area, or just below current levels, so "it wouldn't surprise me to see some countertrend rally," Hochberg said, suggesting investors still long the metal and related shares use any such rally to lighten up.

Notably, the Philadelphia Stock Exchange Gold & Silver Index slid 0.3% Monday despite gold's modest advance.

For the record, I'm still long the

(TGLDX) - Get Report

Tocqueville Gold fund, which I've always thought of as a genuinely long-term investment/hedge.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.