The poor sales data combined with an unexpectedly sharp drop in wholesale prices overshadowed better-than-expected earnings reports from Johnson & Johnson and Goldman Sachs, leading the Dow Jones industrial average down 137.63, or 1.71 percent, to 7,920.18, according to preliminary calculations.
Broader market measures also lost ground after three days of gains. The Standard & Poor's 500 index fell 17.32, or 2.01 percent, to 841.51, and the Nasdaq composite index fell 27.59, or 1.67 percent, to 1,625.72.
Financial stocks were especially weak after Goldman said it would raise $5 billion to repay government bailout money. Investors speculated that other major banks might follow suit, which would put pressure on their stocks. Citigroup Inc. and JPMorgan Chase & Co. are also due to report results this week.
Tuesday's selling was orderly and extended a give-and-take pattern the market has followed since halting a steep slide in early March. Stocks have risen above 12-year lows since then on hopes that banks are getting through the worst of their problems and the economy might be bottoming out.
Jeffrey Frankel, president of Stuart Frankel & Co. in New York, said he would be more concerned if the market's rally had continued unchecked given the problems facing the economy and the likelihood that any recovery will be slow.
"This is healthy. You don't want to go straight up," he said.
The unexpected slump in retail sales, which fell 1.1 percent in March, undermined the market's brightening outlook for the economy. The drop was far worse than the increase of 0.3 percent that analysts polled by Thomson Reuters had been expecting and marked the biggest fall in three months. Investors watch retail sales trends closely as a barometer of consumer spending, which makes up two-thirds of U.S. economic activity.
"The choppy data that we're seeing, whether it's economic or earnings, reminds us that we're still not out of the woods," said Sean Simko, head of fixed income management at SEI Investments in Philadelphia. "The market always has a tendency to go too far too fast."
Investors took little comfort from speeches by President Barack Obama and Federal Reserve Chairman Ben Bernanke that there have been hopeful signs about the economy and that a sustained recovery won't arrive quickly.
A separate report on wholesale prices released Tuesday gave another poor reading on the economy.
The Labor Department said wholesale prices tumbled 1.2 percent in March as the cost of gasoline, other energy products and food fell sharply. Falling prices fan worries about a spiraling effect where consumers and businesses would halt spending out of fear that they would pay too much for something today that could be worth less tomorrow.
The drop in stocks followed more signs that companies reporting earnings for the January-March quarter might be able to top Wall Street's modest expectations.
Johnson & Johnson said its first-quarter profit dipped, but not as much as expected. The health care products maker earned $3.5 billion, or $1.26 per share, above analysts' estimates of $1.22 per share. J&J, one of the 30 stocks that make up the Dow, rose 52 cents, or 1 percent, to $51.67.
Goldman released its results a day early, reporting after the closing bell Monday that it earned $1.66 billion in the quarter, well above what analysts were expecting. The company said it would raise $5 billion in stock in hopes of repaying the $10 billion investment it received from the government last year.
Goldman shares fell $12.02, or 9.2 percent, to $118.13 after its stock offering was priced at $123 per share, a discount of 5.5 percent to Monday's closing price.
Some other financial stocks also slid. JPMorgan fell $1.78, or 5.3 percent, to $31.92, while Morgan Stanley fell $2.69, or 10 percent, to $24.20.
In other market moves, the Russell 2000 index of smaller companies fell 11.22, or 2.4 percent, to 456.83.
Two stocks fell for every one that rose on the New York Stock Exchange, where volume came to 1.2 billion shares.
Bond prices rose after the weak economic readings. That pushed the yield on the 10-year Treasury note down to 2.78 percent from 2.86 percent late Monday.
The dollar was mixed against other major currencies, while gold prices fell.
Light, sweet crude fell 58 cents to $49.47 a barrel on the New York Mercantile Exchange.
Overseas, Japan's Nikkei stock average fell 0.9 percent. Britain's FTSE 100 rose 0.1 percent, Germany's DAX index gained 1.5 percent, and France's CAC-40 rose 0.9 percent.