Financial stocks drag Wall Street down

Stocks slid on Tuesday after a prominent banking analyst warned that the sector's fundamentals have not yet improved, sparking a sell-off in bank shares.

Economic data showing an unexpectedly large fall in wholesalers' inventories added to the bearish sentiment.

The drop in inventories in June, which was nearly double expectations, suggests that businesses remained skeptical about a return in demand.

Financial stocks, which had gained about 25 percent in the last month, tumbled after Rochdale Securities analyst Richard Bove painted a gloomy outlook for the banking industry. He said bank stocks are trading on fumes, and he expects a short-term pull-back in their stock prices.

Among banking stocks, Bank of America was down 4.8 percent to $15.88 and JPMorgan Chase was down 3 percent to $41.40.

Bank (shares) have been rallying because low interest rates have helped them make money, said Keith Springer, president of Capital Financial Advisory Services in Sacramento, California. But the deleveraging process is removing tens of billions from the economy. We're going to see a lot more defaults.

A report from the Congressional Oversight Panel, a U.S. bailout watchdog, issued late Monday highlighted the rocky road facing the banking industry. The panel said toxic loans and securities continue to pose a threat to the financial system, particularly for smaller banks that face mounting losses on commercial real estate loans.

The Dow Jones industrial average <.DJI> was down 98.85 points, or 1 percent, at 9,239.10. The Standard & Poor's 500 Index <.SPX> slid 13.65 points, or 1.4 percent, at 993.45. The Nasdaq Composite Index <.IXIC> fell 28.08 points, or 1.4 percent, at 1,964.16.

Springer said there is a little pullback after the recent rally that sent the broader S&P index to a 10-month high last week and up nearly 50 percent from a closing low set on March 9.

Stocks slightly pared losses after results from a government auction of U.S. Treasuries at midday.

Investors were also cautious ahead of a two-day monetary policy meeting by the U.S. Federal Reserve that kicks off Tuesday afternoon and July retail sales data due Thursday.

With quarterly earnings reports also due this week from retail giants Wal-Mart , J.C. Penney and Macy's , investors will look to see if consumer spending, which accounts for roughly two-thirds of the U.S. economy, is stabilizing.

Another worrying sign of a still-weak economy came from hedge fund firm Atticus Capital LLC, which told investors that it is closing two of its three funds and would return $3 billion to shareholders.

The financial sector of the S&P 500 <.GSPF> dropped 3.3 percent. The S&P Regional Banks sub-index <.GSPBNKS> was off 4.4 percent, while the KBW Bank Index <.BKX> was down 4.5 percent.

Adding to losses for financials, Miller Tabak cut its price targets on Zions Bancorp and Regions Financial Corp . Shares of Zions dropped 9.8 percent to $16.17, while Regions dropped 4.43 percent to $4.75.

The negative news offset better-than-expected data on U.S. non-farm productivity in the second quarter, which showed worker productivity rose at the fastest pace in six years as hours worked fell much more steeply than output.

(Editing by Leslie Adler)