"It's clearly a follow-through from yesterday's late afternoon swoon," said Jay Suskind, director of trading at Ryan, Beck & Co. "If the yield on the 10-year [bond] heads back to 5.25%, that's not a good thing for the market."
The Dow Jones Industrial Average fell 40 points to 13,451, as 22 of its 30 stocks retreated, led by McDonald's Corp. and Honeywell Corp. .
Exxon Mobil was the biggest gainer among blue chips. Crude oil gained 70 cents, or 1%, to $69.57 as a general strike in Nigeria fueled concerns about oil production.
Investors were also concerned that the meltdown in the U.S. subprime mortgage market might cause more trouble for hedge funds. The Wall Street Journal reported that the collapse of two big Bear Stearns hedge funds marks a test of the resiliency of the financial markets.
"People are wondering where the supbrime derivative tentacles are going to end up," Suskind said.
On Thursday, JP Morgan Chase , a Dow component, said it came to terms with Bear Stearns, and didn't auction the collateral it held from a Bear hedge fund, a person briefed on the matter told the newspaper.
The S&P 500 index fell 1.3 points to 1,511, while the Nasdaq Composite dropped 1.4 points to 2,598.
Trading volumes showed 301 million shares exchanging hands on the New York Stock Exchange and 384 million trading on the Nasdaq stock market. Declining issues topped gainers by 17 to 11 on the NYSE and by 3 to 2 on the Nasdaq.
By sector, utilities , airlines and broker/dealers led the declines, while oil , natural gas and semiconductors .
Yields back in focus
News that U.S. jobless claims reached their highest level since April, rising 10,000 to 324,000 in line with expectations, did little to move the bond market, which has been the focus of investor attention in recent weeks.
But the benchmark 10-year Treasury bond was last down 4/32 at 94 29/32, sending its yield up to 5.14%.
The market tumbled when yields rose on Wednesday.
Investors are focusing more and more on possible inflationary pressures coming from the labor market, which might prevent the Federal Reserve from cutting interest rates this year and, according to some, might lead the Fed to raise rates.
Bonds, which lose value when inflation rises, have been under pressure for several weeks amid signs of rising inflation globally. U.S. bond yields, which move inversely to price, have topped 5%, offering a risk-free alternative to stocks and lifting borrowing costs for consumers and businesses.
The market will next focus on the release of the Philadelphia Federal Reserve's June index of regional business activity at noon Eastern, which is expected to rise to a reading of 8.0 from 4.2 in May.
"I suspect that today's Philly Fed expectations are too low, in light of what we saw from the Empire State Index," said Marc Pado, market strategist at Cantor Fitzgerald.
Should the Phily Fed index top expectations, yields may rise and pressure the stock market further.
Of companies in focus, the board of Dow Jones said it was taking over negotiations with News Corp over a proposed $5 billion buyout from the Bancroft family that holds a controlling stake in the publisher of The Wall Street Journal. Separately, MySpace founder Brad Greenspan said he's willing to pay $1.25 billion for 25% of Dow Jones shares in a tender offer, with Greenspan saying he could boost traffic to Dow Jones Internet properties. Dow Jones is the owner of MarketWatch, the publisher of this report.
Luxottica agreed to buy Oakley for $2.1 billion, or $29.30 a share, an 18% premium to Wedneday's close.
H&R Block reported a loss and forecast current year earnings per share to be below analyst expectations.
Handset maker Nokia fell after it was downgraded to neutral from buy at Goldman Sachs, citing a more balanced risk/reward following a recent strong run.
By Nick Godt