Updated from 4:16 p.m. EDT

Selling pressure that began after a discouraging report on the service sector worsened throughout the session Wednesday, and the major averages closed the day with steep losses.

The Dow Jones Industrial Average dropped 123.75 points, or 1.2%, to 10,317.36, and the S&P 500 fell 18.08 points, or 1.5%, to 1196.39. The Nasdaq Composite sank 36.34 points, or 1.7%, to 2103.02. The 10-year Treasury was up 5/32 in price to yield 4.35%, while the dollar fell against the yen and euro.

"The market went berserk to the wrong side," said Robert Pavlik, chief investment officer with Oaktree Asset Management. "Everything is reacting the wrong way. There's all the talk of inflation, but it's overdone. Everything is just very negative."

Since the start of the week, the Dow has lost 2.4%, the S&P 500 is down 2.6%, and the Nasdaq has fallen 2.2%.

Caterpillar ( CAT) and Hewlett-Packard ( HPQ) were two of the Dow's biggest losers, down 2.7% and 3.8%, respectively.

About 1.91 billion shares traded on the New York Stock Exchange, with decliners beating advancers by a 9-to-2 margin. Trading volume on the Nasdaq was 1.96 billion shares, with decliners outpacing advancers 4 to 1.

Energy prices finished Wednesday's session lower amid concerns about the strength of demand. Crude for November delivery slumped $1.11 to $62.79 a barrel. Unleaded gasoline futures were down 11 cents to $1.92 a gallon, and natural gas was lower by 4 cents to $14.18 per mmBtu after closing at a record high Tuesday.

After the Energy Department's weekly inventory report, which showed a 300,000-barrel decline in crude inventories, prices had moved much higher before sliding. Gas stocks were down by 4.3 million barrels, while distillate stores were lower by 5.6 million barrels.

On the economic front, the Institute for Supply Management's services index for September fell to 53.3 from 65.0 in August, pointing to a slower pace of expansion. A reading above 50 signals growth, but economists expected the number to come in at 60.0. At the same time, the prices-paid component of the index jumped, supporting the Federal Reserve argument that inflationary pressures are becoming more tangible.

"I'm not really surprised, as the drop in consumer confidence was due to leak into the services industry," said Paul Mendelsohn, chief investment strategist with Windham Financial. "We're now seeing the impact of the two hurricanes roll into the economic data."

"We're finally seeing energy prices come through in data today, which scared investors," said Paul Nolte, director of investments with Hinsdale Associates. "We're still in a trading range. We haven't moved out of that range at all, but once we break it, we could see a significant move."

Virtually every sector was weaker Wednesday, with technology, health care, energy and materials leading the decliners.

The New York Times reported Wednesday that financially troubled auto-parts maker Delphi ( DPH) may file for bankruptcy as early as this week. Delphi tumbled 10.1%, down 28 cents to $2.50.

Meanwhile, General Motors ( GM) and the United Auto Workers union, both of which could make concessions to save Delphi from bankruptcy, are nearing a deal to cut the automaker's health care costs, according to an online report from The Detroit News. The deal is expected to slash more than $1 billion in annual health costs. GM was the worst loser on the Dow, falling $1.44, or 4.8%, to close at $28.64.

Among earnings, Yum! Brands ( YUM) posted a third-quarter profit of $214 million, or 72 cents a share, up from $185 million, or 61 cents a share, a year ago. Revenue rose to $2.24 billion from $2.18 billion last year.

Excluding certain items, the fast-food restaurant company earned 71 cents a share, beating the Thomson First Call consensus by a penny. The company also raised its full-year outlook. Yum! added 56 cents, or 1.2%, to $48.83.

Meanwhile, Wendy's ( WEN) said third-quarter same-store sales declined 5% in the U.S. Same-store sales at franchised restaurants fell about 5.5% for the quarter. The restaurant operator said same-store sales were hurt by store closings after hurricanes Katrina and Rita, high gasoline prices and lower consumer spending levels.

Wendy's also estimates that the effects of Katrina and Rita will lower earnings by 2 cents a share in the third quarter, while higher beef prices will knock off an additional 2 cents. Wendy's also will continue to work on an initial public offering for its Tim Hortons business. Wendy's rose 61 cents, or 1.3%, to $47.33.

Entergy ( ETR) said Wednesday that it expects damage caused by Hurricane Rita to be in a range of $400 million to $550 million. Because of power outages related to the hurricanes, Entergy expects lower revenue as well. The stock ended down $2.32, or 3.1%, to $72.10.

In ratings moves, Citigroup downgraded BP ( BP) to hold from buy, a day after the company estimated that hurricanes Katrina and Rita will cut its third-quarter replacement cost profit by more than $700 million, before interest and tax. BP was off $2.30, or 3.3%, to close at $66.50.

Legg Mason cut Phelps Dodge ( PD) to hold from buy, citing valuation. The firm noted rising copper and energy prices are expected to slow economic growth and affect the stock. Phelps Dodge was lower by $6.17, or 4.6%, to $128.33.

Prudential downgraded Maytag ( MYG) to underweight from neutral, citing earnings deterioration. Maytag lost 44 cents, or 2.4%, to $17.56.

Overseas markets were uniformly lower, with London's FTSE 100 down 0.9% at 5446 and Germany's Xetra DAX losing 1% to 5085. In Asia, Japan's Nikkei lost 0.4% overnight to 13,690, while Hong Kong's Hang Seng was down 1.4% at 15,161.