The Dow Jones Industrial Average sank 370.03 points (2.93 percent) to end at 12,265.13 after sharp losses on Monday.
The tech-heavy Nasdaq composite plummeted 73.28 points (3.08 percent) to 2,309.57 and the broad-market Standard & Poor's 500 index slid 44.18 points (3.20 percent) to 1,336.64.
Sentiment took a hit as a report from the Institute of Supply Management showed the vast services sector of the US economy contracted in January for the first time in nearly five years.
The ISM index on nonmanufacturing activity slumped to 41.9 percent in January from 54.4 percent in December, well below the level of 50 percent indicating growth and stunning analysts expecting a much stronger figure.
David Rosenberg, economist at Merrill Lynch, said the report signals the economy may be in even worse condition than anticipated and might force the Federal Reserve to cut rates again before its March 18 meeting.
"Indeed, not only is the economy in a downturn, the abruptness and depth of th