Stocks fell on Tuesday after data showed an unexpectedly large drop in inventories at wholesalers in June, while an analyst's warning that fundamentals for the banking industry have not improved sent financial sector shares lower.

The magnitude of the monthly drop in inventories in June, a fall of 1.7 percent, was nearly double the 0.9 percent decline analysts expected, which knocked stock indexes more than 1 percent lower as investors worried businesses were cutting inventories sharply because they remained skeptical about a return in demand.

The Dow Jones industrial average <.DJI> was down 95.45 points, or 1.02 percent, at 9,242.50. The Standard & Poor's 500 Index <.SPX> was down 11.24 points, or 1.12 percent, at 995.86. The Nasdaq Composite Index <.IXIC> was down 26.68 points, or 1.34 percent, at 1,965.56.

The drop in inventories suggests that businesses continue to be cautious and that production is below demand, said Alan Gayle, senior investment strategist at Ridgeworth Investments in Richmond, Virginia.

Most analysts are expecting inventory cuts to slow over the third quarter, and it looks as though that hasn't materialized. That's an important growth factor in the second half recovery.

Financial stocks tumbled after Rochdale Securities analyst Richard Bove painted a gloomy outlook for the banking industry, saying that bank stocks are trading on fumes, and that he expects a short-term pull-back in the stock prices after a recent rise.

The S&P Regional Banks sub-index <.GSPBNKS> was off 4.08 percent, while the KBW Bank Index <.BKX> was also down 3.34 percent.

On top of the disappointing outlook, Miller Tabak cut price-targets on Zions Bancorp , taking the stock down nearly 10 percent to $16.23. Regions Financial Corp dropped 3 percent at $4.82 on a similar note.

CIT Group Inc fell 22 percent to $1.15 after the company said it would file for bankruptcy protection if it failed to complete its debt tender or arrange other financing.

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

Investors are closely eyeing the two-day monetary policy meeting by the U.S. Federal Reserve that kicks off on Tuesday. While interest rates are likely to remain at current levels, the focus will be on signs of an exit strategy from the Fed's quantitative easing policy.

Also Tuesday, Applied Materials Inc , the world's largest chip equipment maker, reports third-quarter earnings after the bell.

Wall Street ended lower Monday after investors sold off some equities after a four-week rally took the broad S&P 500 index to a 10-month high last week. The index is now up 48 percent from its 12-year closing low set on March 9.

(Additional reporting by Ryan Vlastelica; Editing by Padraic Cassidy)

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