In Italy, investors erased most of an early rally in the country's stock market and dumped government bonds, sending yields higher.
The yield on Italy's 10-year government bond shot up to 4.43 percent from 4.12 percent early in the day, a sign that investors' confidence in the government was dimming quickly.
In the U.S., some analysts say the stock market had gotten ahead of itself with a strong rally since the start of the year. The news from Italy gave investors a reason to sell. Even after today's sell-off the Dow is still up 5.2 percent for the year and the S&P 500 is 4.3 percent higher.
"The market is extremely overbought, it's been overbought since the beginning of this year," says Lance Roberts, chief economist at Streettalk Advisors in Houston, Texas.
US Bank Wealth Management's Russell says many investors were already jittery because the big jump in stocks. Now they have two reasons to sell: Italy, and the automatic budget cuts set to take effect Friday if lawmakers do not hammer out a debt-reduction deal.
"Markets have probably gone up too far, too fast," Russell says. "They were due for pause."
European stocks gave back much of their early gains. Benchmark indexes rose 0.4 percent in France, 1.5 percent in Germany and 0.8 percent in Spain.
Britain's index was up just 0.3 percent after Moody's stripped the country late Friday of its triple-A credit rating.
Among other stocks making big moves:
— Drugmaker Affymax plunged $14.10, or 85 percent, to $2.42 after the company recalled its anemia drug following severe allergic reactions and the deaths of some kidney dialysis patients.
—Mead Johnson fell $3.64, or 4.6 percent, to $75.32 after the company said that a new regulation in Hong Kong could affect the company's sales there as well as in mainland China.
— Barnes & Noble rose $1.55, or 12 percent, to $15.06 after founder and chairman Leonard Riggio told the bookseller he is going to try to buy the company's retail business.
— Hertz advanced 31 cents, or 1.7 percent, to $19.04, despite posting a fourth-quarter loss, after the rental car company said that pricing improved, volume rose and it cut costs.
AP Business Writers Christina Rexrode and Matthew Craft contributed to the report.