Markets in mainland China were closed for National Day holidays. They reopen on Oct. 8. India's markets area also closed. The Kospi in South Korea sank 1.8%, to 2,035.58 after North Korea fired a ballistic missile toward the sea Wednesday, South Korea's military said. The display of Pyongyang's expanding military capabilities came just hours after it said it would resume nuclear diplomacy with the United States this weekend.
The U.S. factory report showed that manufacturing weakened in September for the second straight month as President Donald Trump's trade war with China dragged on confidence and factory activity. It dashed economists' belief that August's contraction was an aberration, and stocks and bond yields immediately reversed course to drop sharply lower following the report.
Still, other manufacturing data was less gloomy, said Jeffrey Halley of Oanda. "The U.K, core Latam and emerging Asia seem to be holding their own, and it is far too soon to say that the U.S. is about to wither on the vine," he said.
"If they are doing so in such a toxic global trade environment, then imagine how they may perform if we get a trade breakthrough in the coming weeks. It's not all doom and gloom in the Markits," Halley said in a commentary.
Overnight, the S&P 500 slumped 1.2% to 2,940.25 for its sharpest loss since August. The Dow Jones Industrial Average fell 1.3% to 26,573.04, and the Nasdaq composite dropped 1.1% to 7,908.68. Small-company stocks fell more than the rest of the market. The Russell 2000 index lost 2%, to 1,493.43.
In the bond market, the yield on the 10-year Treasury dropped to 1.65% from 1.74% before the report's release, which is a big move. Three stocks fell for every one that rose on the New York Stock Exchange, and gold climbed as investors sought safer ground.
Manufacturing is a relatively small part of the economy, but investors worry about whether it will spill into other areas. That puts an even bigger spotlight on Friday's jobs report, which economists expect to show an acceleration in hiring.
"Granted, manufacturing equates to a mere 11% of U.S. GDP, but the market ... is incredibly sensitive to the outcome," Chris Weston of Pepperstone said in a report. The protracted trade war with China is hammering export manufacturing. It also raises uncertainties over the future rules of international trade, causing CEOs to curb spending. In a separate report, the World Trade Organization said global trade growth will slow to its weakest pace this year since 2009.
Household spending has been a pillar for the economy, particularly when manufacturing and business spending are under threat, and a strong job market helps households keep spending. But a report last week showed consumer spending rose less than economists expected in August. Two reports on consumer confidence last week gave a mixed picture, with one falling below expectations and the other rising above.
The Fed and other central banks have been aggressive in keeping interest rates low to shield against the effects of the trade war and slowing global economic growth. The Fed lowered short-term rates twice this summer, down to a range of 1.75% to 2%, the first cuts since the financial crisis was toppling economies around the world in 2008.
In energy trading, benchmark crude oil rebounded, gaining 66 cents to $54.28 per barrel in electronic trading on the New York Mercantile Exchange. It fell 45 cents to $53.62 a barrel on Tuesday. Brent crude oil, the international standard, picked up 46 cents to $59.35 per barrel.
The dollar rose to 107.81 Japanese yen from 107.73 yen on Tuesday. The euro was flat at $1.0935.
AP Business writers Damian J. Troise and Alex Veiga contributed.