US STOCKS-Wall Street drops as shutdown drags on for third day

Thu Oct 3, 2013 12:09pm EDT

* Investors fear debt limit decision will be tied to budget battle

* S&P 500 on track for ninth loss in past 11 sessions

* Growth in the U.S. service sector slows last month

* Indexes down: Dow 1.2 pct, S&P 1.4 pct, Nasdaq 1.6 pct

By Julia Edwards

NEW YORK, Oct 3 (Reuters) - U.S. stocks fell on Thursday as a partial U.S. government shutdown entered its third day, with investors growing concerned that the budget stalemate will become intertwined with a coming deadline to raise the debt limit.

Weaker-than-expected growth in the U.S. service sector also added to the negative tone. The government closure has had a limited effect on markets thus far, but the impact is gathering a bit of strength as concerns over raising the U.S. borrowing authority have risen.

The three major indexes fell more than 1 percent.

The situation in Washington has pressured equities, with the S&P 500 having dropped in nine of the past 11 sessions. All 10 S&P sectors fell, with industrial names among the hardest hit. Boeing Co fell 2.5 percent to $115.33.

President Barack Obama met with Republican and Democratic leaders in Congress late Wednesday to try to break the budget deadlock, but no breakthrough seems to be in sight. Markets took a turn for the worse after Obama, in a speech, reiterated that he would not meet Republican demands in exchange for operating the government.

The Treasury has said the United States will exhaust its borrowing authority no later than Oct. 17. If no deal is reached on raising the debt ceiling, the United States could default on its debt.

"What's happened in Washington? Nothing. When people are uncertain about what's going to happen, they sell first and ask questions later," said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles.

"I think the feeling on Tuesday was, 'OK the government's shut down, but they're going to do soemthing in a day or two.' Now we're in day three, and people are getting both a little concerned and annoyed."

The Dow Jones industrial average was down 182.12 points, or 1.20 percent, at 14,951.02. The Standard & Poor's 500 Index was down 22.87 points, or 1.35 percent, at 1,671.00. The Nasdaq Composite Index was down 60.13 points, or 1.58 percent, at 3,754.89

The CBOE Volatility Index, the market's favored indicator of Wall Street anxiety, rose 11 percent to 18.44.

The S&P 500 broke below its 50-day moving average of 1,679.88. The moving average represents a measure of the near-term trend in the market. Once the index falls convincingly below the 50-day moving average, investors often will sell shares.

Goldman Sachs estimated on Wednesday a short-term shutdown would slow U.S. economic growth by about 0.2 percentage point, while a weeks-long disruption could shave 0.4 percentage point off growth, as furloughed workers trim personal spending.

The weakest sectors Thursday were utilities and industrials. Utilities are generally heavy debt issuers, and Warren West, principal at Greentree Brokerage Services in Philadelphia, noted that their borrowing costs are vulnerable if rates rise.

"When you think that people on Capitol Hill might just lose their minds and push us over the cliff, are very vulnerable," said West.

"If there's a crisis in the debt markets because we weren't able to get a resolution on the debt ceiling, our borrowing costs are going to go up dramatically."

The utilities sector was down 1.4 percent. Exelon Corp lost 1.9 percent.

Growth in the U.S. service sector cooled last month to 54.4 after approaching an eight-year high of 58.6 in August, according to the Institute for Supply Management's September non-manufacturing index.

Tesla Motors Co shares fell 4.38 percent to $172.84 after an automotive blog published images of a Model S electric sedan in flames after an accident.