Stocks sank more than 1 percent on Friday after a Republican proposal for averting the "fiscal cliff" failed to pass, diminishing hopes a deal would be reached soon in Washington.
Trading is expected to be volatile as investors view a fiscal agreement between the White House and Republicans before the year-end as increasingly unlikely. With volume thin ahead of the holidays, market swings could be amplified. The CBOE Volatility index jumped 11.5 percent.
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Late on Thursday, Republican House Speaker John Boehner conceded there were insufficient votes from his party to pass a tax bill, dubbed "Plan B," to help avert the cliff, $600 billion of tax hikes and spending cuts due to start in January that could tip the economy into recession.
Plan B had called for tax increases on those who earn $1 million a more a year, and the bill's failure suggested it would be difficult to get Republican support for the more expansive tax increases Obama has urged, making it less likely an agreement will be reached between the White House and Republicans before the end of the year.
"We had been moving in the right direction, but now we need a different deal, and if this radical group of Republicans is so intransigent that they won't do any deal, it will be very difficult," said Wayne Kaufman, chief market analyst at John Thomas Financial in New York.
Banking shares, which outperform in times of economic expansion and have led the market on signs of progress with the fiscal impasse, were among the hardest hit on Friday. Citigroup Inc sank 2.5 percent to $39.15 while Bank of America was off 2.5 percent to $11.23. The KBW Banks index lost 1.4 percent.
The Dow Jones industrial average was down 134.93 points, or 1.01 percent, at 13,176.79. The Standard & Poor's 500 Index was down 16.08 points, or 1.11 percent, at 1,427.61. The Nasdaq Composite Index was down 45.57 points, or 1.49 percent, at 3,004.82.
The S&P 500 is up about 1 percent on the week and 14 percent on the year, though uncertainty over the cliff may prompt many traders to lock in gains as the year draws to a close.
The Thomson Reuters/University of Michigan's final December reading on consumer sentiment fell to 72.9, weaker than expected, as Americans were rattled by the stalemate in the fiscal negotiations.
Orders for durable goods rose 0.7 percent in November, more than expected, while personal income and spending were also higher than forecast.
Nike Inc and Red Hat Inc were the top two percentage gainers on the S&P 500. Nike rose 4.8 percent to $103.76 after reporting second-quarter earnings that handily beat expectations, while Red Hat gained 4.8 percent to $55.12 on the back of strong revenue.
U.S.-listed shares of Research in Motion slumped 17 percent to $11.70 after reporting its first-ever decline in its subscriber numbers late Thursday.
(Editing by Bernadette Baum)