Stocks fell on Friday after government data showed a larger-than-expected drop in July payrolls, giving investors a stark reminder the economic recovery remains slow.

Stocks had been rising over the past five weeks, largely on the back of solid corporate earnings. The S&P 500 is still up 9.7 percent from its closing low for the year set July 2.

The hope was that we would have a great earnings season, and frankly the S&P has delivered on that in spades, said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

The disappointment is that in spite of the delivery of great earnings, you still have an economy that is not engaged and clearly not improving on the employment front.

The U.S. economy lost 131,000 jobs in July -- more than twice the decline of 65,000 that economists forecast in a Reuters poll. And the closely watched private employment number rose less than expected.

Of the 443 companies in the S&P 500 that have reported earnings to date, 75 percent have reported earnings above analysts' expectations, with only 9 percent missing estimates, according to Thomson Reuters data.

Consumer stocks ranked among the worst performers as the monthly jobs report highlighted worries about consumer spending, which accounts for about two-thirds of U.S. economic activity. Retailer Office Depot , which sells school and office supplies, slid 7 percent to $4.54, while the S&P consumer discretionary index <.GSPD> shed 0.5 percent.

The Dow Jones industrial average <.DJI> dropped 21.42 points, or 0.20 percent, to 10,653.56. The Standard & Poor's 500 Index <.SPX> shed 4.17 points, or 0.37 percent, to 1,121.64. The Nasdaq Composite Index <.IXIC> lost 4.59 points, or 0.20 percent, to 2,288.47.

For the week, the Dow and the S&P 500 each rose 1.8 percent, while the Nasdaq advanced 1.5 percent.

DOW RETRACES MOST OF 160-POINT DROP

In late afternoon trading, stocks sharply pared back losses that had driven the major indexes down 1 percent or more to their session lows.

Big swings in stocks are more common on days with light volume, On Friday, only about 7.17 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq, below last year's estimated daily average of 9.65 billion.

By Friday's close, the Dow, for instance, had recovered a large portion of its drop of about 160 points that had taken it to an intraday low at 10,515.37. The S&P 500 followed suit, retracing much of its loss for the day. At one point, the S&P was down as much as 18.64 points, which took it down to an intraday low of 1,107.17. The Nasdaq had fallen as much as 39.14 points to a session low at 2,253.92, before regaining much of that ground by the close.

The late-day recovery pushed both the S&P and Nasdaq back into positive territory for the year.

If you look through it all, it seems like the market wants to go up, that's the important thing, said Terry Morris, senior equity manager for National Penn Investors Trust Company in Reading, Pennsylvania.

Economic data is going to continue to be frustrating, but within the context of the economy stabilizing and slowly improving. Investors will want to look through these short-term blips and want to buy, for now.

HP SLIDES LATE AFTER CEO QUITS

After the closing bell, Hewlett-Packard Co Chief Executive Mark Hurd resigned on Friday following an investigation of sexual harassment, the world's top computer maker said.

Shares of HP, a Dow component, tumbled 9 percent to $42.14 in extended-hours trading. The stock was initially halted after the news.

During the session, Dow component Kraft Foods Inc was among the bright spots, rising 2.4 percent to $30.36 after the company, whose products include Kraft cheese and Maxwell House coffee, reported a higher-than-expected quarterly profit. Kraft also raised its target for cost savings from its acquisition of Cadbury, the British company known for its chocolates.

Shares of American International Group Inc. climbed 2.6 percent to $40.93 after its quarterly results topped Wall Street's expectations and its chief executive said the insurer is actively looking to repay its taxpayer bailout.

Shares of grain companies like Archer-Daniels-Midland Co and Bunge Ltd continued to outperform the overall market after rallying more than 5 percent on Thursday, on expectations their wheat exports will be increased by Russia's decision to suspend grain shipments as it faces its worst drought in a century.

Bunge shot up 2.2 percent to $55.66, while Archer-Daniels-Midland slipped 0.2 percent to $30.18.

Declining stocks outnumbered advancing ones on the New York Stock Exchange by a ratio of about 8-to-7, while on the Nasdaq, three stocks fell for every two that rose.

(Reporting by Chuck Mikolajczak; Additional reporting by Rodrigo Campos; Editing by Jan Paschal)

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