"We're seeing a continuation of the sell-off of the last couple of days, based on the move up in yields, and particularly with the 10-year bond above 5%," said Mike Malone, trading analyst at Cowen & Co.
Adding to those concerns, crude oil topped $67 a barrel, amid delayed tanker loadings as a storm in the Persian Gulf was headed towards Iran.
The Dow Jones Industrial Average fell 35 points to 13,430, as 24 of its 30 stocks retreated, led by the likes of Disney , Home Depot Inc. and Pfizer Inc. .
Among blue-chips, Procter & Gamble fell 0.9%. It was downgraded to equal-weight from overweight at Lehman Brothers on concerns over margin growth.
Wal-Mart Stores lost 1% after it posted a modest gain in May same-store sales, narrowly missing Wall Street estimates, battered by weakness in its apparel and home merchandise.
Overall, however, retailers were posting a slight improvement in May sales after bleak results in April. With most retailers having reported, 50% either beat or met estimates, while the other 50% missed, according to Thomson Financial.
J.C. Penney , Macy's , AnnTaylor and Abercrombie & Fitch all reported sales below estimate, while Costco Wholesale , Limited , Nordstrom and Jos. A. Bank Clothiers beat estimates.
The S&P 500 index eased 7 points to 1,509, while the Nasdaq Composite lost 10.8 points to 2,576.
Trading volumes showed 395 million shares exchanging hands on the New York Stock Exchange and 529 million on the Nasdaq stock market. Declining issues topped gainers by 4 to 1 on the NYSE and by 18 to 8 on the Nasdaq.
10-year yield above 5%
Investors have been warily monitoring rising bond yields since last week. Higher yields make bonds more attractive to investors relative to riskier bets in the stock market.
Better-than-expected economic data, along with hawkish comments by Federal Reserve Chairman Ben Bernanke and other Fed officials have pressured the price of inflation-sensitive bonds, lifting their yields.
Early on Thursday, the yield of the benchmark 10-year Treasury bond finally topped 5% for the first time since August 2006. In recent action, the bond fell 19/32 to 95 24/32, yielding 5.06%.
At the same time, rising interest rates globally are also putting pressure on stocks.
On Thursday, the New Zealand central bank hiked rates to 8%. The Bank of England, on the other hand, held rates unchanged. On Wednesday, the European Central Bank hiked rates and issued a hawkish outlook.
Correction in the cards?
Market analysts also point to the U.S. market's record-setting rally, which began last summer and drove the Dow and the S&P 500 to record highs, with only a short-lived interruption in late February/early March.
"The overbought condition we've been looking at in the market has persisted for 2-1/2 months," said Marc Pado, market strategist at Cantor Fitzgerald. "Bull markets can produce a few 3-month overbought runs, but it typically doesn't last longer than that without some correction back to neutral."
Deals on the backburner
A group of investors including Blackstone Group upped its Biomet offer to $11.4 billion, or $46 a share. The increased offer came as the proxy advisory service Institutional Shareholder Services urged an earlier $44 offer to be rejected.
Dow Jones & Co., could see attention after Brian Tierney, who led a group of investors that bought the Philadelphia Inquirer and Philadelphia Daily News, told The Wall Street Journal that he could be interested in buying the firm. Dow Jones has received an unsolicited $5 billion offer from News Corp . Dow Jones owns the Journal as well as MarketWatch, the pulisher of this report.
PepsiCo and PepsiAmericas agreed to jointly buy 80% of a Ukrainian juice firm, Sandora, for $542 million plus assumed debt. The deal won't affect PepsiCo's earnings but will hurt PepsiAmericas, the companies said.
The dollar advanced against the euro and the yen, finding a bid from rising bond yields and fading expectations that the Fed will cut interest rates.
Oil futures jumped $1.10 to $67.05 a barrel, amid delayed tanker loadings as a storm in the Persian Gulf was headed towards Iran.
Gold turned around as oil surged, last gaining 40 cents to $672.0 an ounce.
By Nick Godt