Stocks fell for a fourth day in a row on Thursday and a measure of investor anxiety hit its highest in five months after the top Senate Democrat warned a deal to avoid fiscal austerity measures may not be reached by the December 31 deadline.
The comments by Senate Majority Leader Harry Reid just days before the hefty tax hikes and spending cuts go into effect pushed stocks down. The S&P 500 has lost 2.7 percent over the past four days, its worst such run in over a month.
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A four-day drop would also mark the S&P 500's longest losing streak in three months as Wall Street wakes up to the possibility that a deal may not be reached until next year.
The CBOE VIX volatility index , a measure of investor fear, jumped above 20 for the first time since July, climbing around 4 percent in another sign of growing concern. Investors fear the so-called fiscal cliff could push the economy into recession next year.
The VIX's "recent spike seems to suggest that market participants are bracing for a rather significant uptick in market volatility in early 2013," said Frederic Ruffy, options strategist at WhatsTrading.com.
Stocks in the materials and the financial sectors, which are more vulnerable to the economy's performance, took the brunt of the selling. Shares in Bank of America fell 2 percent to $11.29, while Freeport-McMoRan Copper & Gold fell 1.6 percent to $33.38.
Reid criticized Republicans for refusing to go along with any tax increases as part of a compromise solution with Democrats. Referring to the fiscal cliff, he said: "It looks like where we're headed."
The Dow Jones industrial average was down 106.63 points, or 0.81 percent, at 13,007.96. The Standard & Poor's 500 Index was down 12.33 points, or 0.87 percent, at 1,407.50. The Nasdaq Composite Index was down 27.48 points, or 0.92 percent, at 2,962.68.
Frank Lesh, a futures analyst and broker at FuturePath Trading in Chicago, said his clients have been delaying trading due to uncertainty about the fiscal cliff, making the year-end period quieter than usual.
"With the added drama in Washington, we have got even more people sidelined," he said. "No one knows how this turns out or how the markets are going to react to it."
President Barack Obama arrived back in Washington from Hawaii to restart stalled negotiations with Congress. House Speaker John Boehner and other Republican leaders were to hold a conference call with Republican lawmakers. The expectation was that lawmakers would be told to get back to Washington quickly if the Senate passed a bill.
Treasury Secretary Timothy Geithner announced the first of a series of measures that should push back the date when the U.S. government will hit its legal borrowing authority - a limit known as the debt ceiling - by about two months.
Economic data seemed to confirm worries about the impact of the fiscal cliff on the economy.
The Conference Board, an industry group, said its index of consumer attitudes in December fell to 65.1 as the budget crisis dented growing optimism about the economy. The gauge fell more than expected from 71.5 in November.
However, the job market continues to mend. Initial claims for unemployment benefits dropped 12,000 to a seasonally adjusted 350,000 last week and the four-week moving average fell to the lowest since March 2008.
But recent signs that the economy is improving have taken a back seat to the political uncertainty.
"The U.S. equity market has not yet adequately responded to a genuinely improving macro backdrop, and is probably held back by uncertainties surrounding the resolution of the 'fiscal cliff'," said Goldman Sachs in a research note.
Marvell Technology Group fell 4.2 percent to $7.09 after it said it would seek to overturn a jury's finding of patent infringement. The stock had fallen more than 10 percent in the previous session after a jury found the company infringed patents held by Carnegie Mellon University and ordered the chipmaker to pay $1.17 billion in damages.
(Reporting by Edward Krudy; Additional reporting by Doris Frankel; Editing by Jan Paschal and Kenneth Barry)