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NEW YORK (Reuters) - U.S. stocks broke a three-day winning streak on Friday as Europe's debt crisis engulfed markets with renewed fears that Spain may be unable to dodge a costly bailout.
The news that the heavily indebted region of Valencia asked Madrid for financial aid interrupted a period of relative calm for Wall Street and raised the specter that the euro zone's fourth-largest economy may itself need to be rescued.
Bank shares, sensitive to signs of trouble in Europe, were among the biggest losers. The KBW bank index .BKX fell 1.9 percent, taking its weekly decline to 2.3 percent. Shares in Morgan Stanley fell 3.5 percent to $12.78.
Valencia, which already used several government credit lines in the first half of the year to meet debt repayments, still needs to repay 2.85 billion euros by the end of the year. That figure is not huge compared to the billions used in other EU bailouts, but investors are concerned about the overall stability of the country and its banks.
"We don't want to go to a full Spanish bailout if we don't have to," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont. "Maybe the market is just over reacting to it, but these days you never know."
The Dow Jones industrial average .DJI was down 120.79 points, or 0.93 percent, at 12,822.57. The Standard & Poor's 500 Index .SPX was down 13.85 points, or 1.01 percent, at 1,362.66. The Nasdaq Composite Index .IXIC was down 40.60 points, or 1.37 percent, at 2,925.30.
The euro slid broadly, setting a two-year low against the dollar. The single currency fell as low as $1.2143, its weakest level since mid-June 2010. Spanish benchmark bond yields hit euro-era highs as the yield on the 10-year bond reached 7.3 percent.
The news overshadowed another round of strong-than-expected corporate earnings, including a profit beat by General Electric (GE.N) and strong advertising revenue at Google (GOOG.O). GE shares gained 0.3 percent to $19.87, giving up some of its earlier gains, and Google added 3 percent to $610.82.
Europe had been on the back burner for much of July, allowing Wall Street to move higher. Since early June the S&P 500 .SPX has gained about 7 percent, helped by a deal to save Spanish banks and a European Union summit that pointed to greater resolve among EU leaders.
Even with Friday's loss, the S&P 500 posted its second weekly gain in a row, climbing 0.4 percent. The Dow ended up 0.4 percent and the Nasdaq composite index rose 0.6 percent for the week.
The resurfacing of euro zone debt problems in the headlines was a reminder that the bloc's problems are far from over. Spain's government also cut its economic growth forecast, indicating the country would stay mired in recession well into next year.
"It looks as if Europe is taking center stage again, with Spain as the main act," said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey.
A gauge of European banks .SX7P dropped 3.7 percent and Spain's equity benchmark .IBEX fell 5.8 percent, its largest daily percentage drop in more than two years.
The S&P on Thursday hit a 2-1/2 month high as record high prices in Treasuries kept yield-seekers focused on stocks despite a softening economy. Bets on further Federal Reserve action in support of the economy are also credited for helping equities to hold up despite poor economic data.
Microsoft (MSFT.O) on Thursday adjusted earnings and revenue that beat expectations, but its first-ever quarterly loss discouraged investors and shares fell 1.8 percent to $30.11.
Schlumberger Ltd (SLB.N) and Baker Hughes Inc BHI.N, the No. 1 and No. 3 oilfield service companies, posted higher-than-expected profits as revenue piled up outside North America despite dark clouds looming over the world economy.
Schlumberger climbed 1 percent to $69.33, while Baker Hughes jumped 9 percent to $45.59.
The S&P energy sector .GSPE has gained for 6 straight days, rising 4.4 percent over the period and 0.3 percent on Friday.
Xerox Corp (XRX.N) fell 4.4 percent to $6.87 after cutting its full-year profit forecast, as it braces for tough economic conditions in Europe.
Kayak Software KYAK.O shares soared 27.6 percent to $33.18 on their Nasdaq debut and Palo Alto Networks (PANW.N) also jumped, up 26.5 percent to $53.13 as they began trading on the NYSE.
About 6.7 billion shares changed hands on the New York Stock Exchange, the Nasdaq and Amex, inline with the 50-day moving average.
Decliners beat advancers by a ratio of about 2 to 1 on the NYSE and on the Nasdaq by almost 3 to 1.
Additional reporting by Rodrigo Campos, editing by Kenneth Barry