A battered financial sector led Wall Street into bear market territory on Thursday, as Bill Gross, manager of the bond fund Pimco, warned that a "financial tsunami" could ensue if the government failed to support markets.

Credit-card groups were among the key casualties as fears grew of rising defaults. American Expressfell 5.3 per cent to $38.75 after Lehman Brothers (NYSE:LEH) forecast net charge-offs - a measure of uncollectable debts - on its cards would reach to 8.5 per cent of loans by next year.

Capital One Financial fell 5.1 per cent to $43.33 after the investment bank cut its price target from $57 to $46.

The decline took in the biggest names in corporate America, such as Lehman Brothers, which dropped 10.5 per cent to $15.17 as investors worried about its ability to raise capital ahead of expected poor earnings and writedowns at the end of the month.

Bank of America slipped 7.2 per cent to $30.60 as options traders placed bets it would lose almost a quarter of its value by late autumn.

Meanwhile, Merrill Lynchdropped 7.5 per cent to $26.21 after reports suggested talks to sell bad loans to Korea Asset Management Corp faced a deadlock.

The wider market slumped, falling for the fourth straight session after an unexpected jump in initial jobless claims and sluggish back-to-school retail sales revived concerns about the health of the economy.

By the close in New York, each of the 10 industry groups were down more than 1 per cent. The S&P 500, down 3 per cent at 1,236.83, had its biggest one-day fall since early June.

The Nasdaq Composite was down 3.2 per cent at 2,2259.04, while the Dow Jones Industrial Average was 3 per cent lower at 11,188.23.

"It's definitely ugly, that's for sure," said Matt King, chief investment officer at Bell Investment Advisors.

The market decline was wide-ranging and took in stocks seen as traditionally defensive. Wal-Mart was one of the only exceptions as down-trading consumers allowed the discounter to escape a retail decline.

Same-store sales beat expectations, helping the shares hold steady at $59.78.

The retail decline was led by TJX Companies, down 7.4 per cent at $34.07, Abercrombie & Fitch, which lost 6.8 per cent to $50.99, Limited Brands down 6.2 per cent to $20.70, and Nordstrom, down 4 per cent at $31.99.

Ken Perkins, president of Retail Metrics, said: "Back-to-school selling was sluggish [during] the first three weeks of August and picked up some toward the end of the month as consumers are shopping closer to need."

The downward momentum swamped news of improved productivity in the second quarter.

Industrials and materials each fell more than 3 per cent. Terex, the maker of construction and mining equipment, was one of the biggest casualties, after cutting its sales and profits forecast for the year. The shares tumbled 19.7 per cent to $38.02.

Caterpillarwas another key laggard, down 5.6 per cent at $63.94.

Steel stocks were shunned after Goldman Sachs issued a more bearish outlook on the sector in a wide-ranging sector note. It said: "A rising US dollar, 'China fear' and sharply falling scrap prices have shaken investor confidence in [the] sustainability of [the] steel cycle."

AK Steelshed 11.1 per cent to $40.84, Allegheny Technologies dipped 4.5 per cent to $44.18 and US Steel fell 5.1 per cent to $112.67.

Technology stocks - which led Wall Street lower the previous day - endured another decline.

Cienadropped 24.9 per cent to $13.09 after the network equipment maker warned that fourth-quarter revenue would be lower than expected.

Oraclefell 6 per cent to $19.93 after a federal judge in San Francisco ruled that its chief executive had failed to turn over evidence that may have proved relevant in a shareholder lawsuit against the company.

Microsoft eased 2 per cent to $26.35 after saying it would cut the price of its Xbox 360 console, in the face of competition from Nintendo's Wii and Sony's PlayStation 3.

Housebuilders were also among the casualties.

Hovnanian Enterprises reported its eighth consecutive quarterly loss after nine years of gains, pushing the shares down 17.4 per cent to $6.40.