Stocks suffered their biggest drop in nearly a year on Tuesday after data showed the worst monthly contraction in the services sector since the last U.S. recession and Standard & Poor's warned it could cut bank credit ratings.

The Dow and S&P 500 had their biggest drops since February 27, 2007. All 30 Dow stocks fell and only 17 of the 500 components on the S&P closed higher.

Recession fears slammed sectors across the board, ranging from telecommunications to energy. Banks and other financial services stocks fell particularly hard after S&P said any loss of a top credit rating by a major bond insurer could force banks to put hobbled bonds back on their balance sheets, curtailing funds available for basic lending.

"This could lead to a further prolonged period of generalized market disruption and a loss of confidence that would not be favorable for any financial institution," the rating agency said.

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The tone for the day was set by the January reading of the Institute for Supply Management's non-manufacturing index. The gauge had its biggest drop since the indicator was created in 1997 and fell to the lowest level since October 2001, aggravating fears that a recession is at hand.

"The U.S is no longer a manufacturing economy, it's a service economy, so this number will carry a lot more weight" than last week's surprise rise in ISM's manufacturing index, said Paul Nolte, director of investments at Hinsdale Associates, in Hinsdale, Illinois. He added that the ISM report will make investors more nervous about other upcoming indicators.

The Dow Jones industrial average was down 370.03 points, or 2.93 percent, at 12,265.13. The Standard & Poor's 500 Index was down 44.18 points, or 3.20 percent, at 1,336.64. The Nasdaq Composite Index was down 73.28 points, or 3.08 percent, at 2,309.57.

Year-to-date, the Dow is down 7.5 percent while the S&P is 9 percent lower. The Nasdaq has fared worse, dropping 12.9 percent so far in 2008.

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