By Herbert Lash
NEW YORK (Reuters) - A weaker-than-expected report on U.S. factory activity slammed global equity markets and the dollar on Monday, pushing Wall Street stocks down more than 2 percent while keeping the pressure on battered emerging market assets.
The benchmark S&P 500 index recorded its worst single-day drop in seven months, while the CBOE volatility index - Wall Street's so-called fear gauge - jumped 16.5 percent to close at its highest level since December 2012.
Trading volume of 9.18 billion shares in U.S. stocks was one-third higher than the daily average in January, according to data from BATS Global Markets.
Emerging market stocks extended a two-week selloff as weak Chinese manufacturing and services data also weighed, while the Turkish lira and South African rand weakened after policymakers dashed expectations of higher local interest rates.
Investment sentiment darkened after the Institute for Supply Management reported U.S. manufacturing activity slowed sharply in January on the back of the biggest drop in new orders in 33 years, while construction spending barely rose in December, suggesting the economy had lost some steam.
The dollar fell to its lowest against the Japanese yen since late November, while the yield on the benchmark 10-year U.S. Treasury note fell to its lowest since early November.
The Dow Jones industrial average closed down 326.05 points, or 2.08 percent, at 15,372.8. The S&P 500 lost 40.7 points, or 2.28 percent, to 1,741.89 and the Nasdaq Composite dropped 106.919 points, or 2.61 percent, to 3,996.958.
MSCI's all-country world equity index fell 1.6 percent, while the pan-European FTSEurofirst 300 index of leading regional shares closed down 1.4 percent.
The selloff pushed both the S&P and MSCI global index back to levels last seen in mid-October.
MSCI's emerging markets index fell 1.1 percent to its lowest since August, but the decline was less than the fall in developed markets. The index is down 6.8 percent so far in 2014, compared with a 5.9 percent drop in the S&P 500.
ISM's index of U.S. factory activity fell to 51.3 last month - its lowest since May - from a revised 56.5 in December. The reading was well below a median forecast of 56 in a Reuters poll of economists. Readings above 50 indicate expansion.
The price of safe-haven gold rose about 1.5 percent as the ISM reading rattled investors, even as data showed European manufacturers had a solid start to the year.
Slower growth in the Chinese goods-producing sectors, coupled with the U.S. data, raised concern about the health of the global economy.
"The data was very weak across the board - it's hard to find any good news in there. It looks like a general slowdown, though you don't know how much of this is weather-related," said Paul Zemsky, head of asset allocation at ING Investment Management in New York, referring to the ISM report.
"Combine that with the fact emerging market currencies continue to sell off, and things don't look too good for the market now," he said. "Somewhere between now and 1,700 (on the S&P) there's a big buying opportunity, but people need to see some stability in emerging currencies."
The dollar index, a measure of the greenback versus basket of currencies, fell 0.35 percent to 81.023 and the euro gained 0.34 percent against the dollar to 1.331. The dollar fell 1.1 percent to 100.92 yen.
U.S. Treasuries yields fell to their lowest since early November, with the 10-year note rising 26/32 in price, pushing its yield down to 2.5716 percent, the lowest since the beginning of November.
Dan Morris, global Investment strategist at TIAA-CREF in New York, where he helps oversee $564 billion in assets, said he was telling clients to keep calm and stay invested, as the decline in U.S. markets was not unexpected.
"I don't think anyone is too shocked this is happening, it was more a question of when and how significant. You were going to have a soft patch," Morris said.
U.S. stocks are likely to post high single-digit returns this year, with forward price-to-earnings ratios of about 15, slightly higher than the past quarter century, he said. But China, because of its size, could be a concern, he added.
Brazil's Bovespa index fell 3.1 percent and its currency, the real, fell. Mexico's bolsa index fell just 0.3 percent.
Gold for April delivery rose 1.5 percent to $1,257.7 an ounce.
Brent crude oil dropped to a two-week low below $106 a barrel as the weak factory data from China stoked concerns about demand, but violence in Iraq and Syria limited the fall.
Brent slipped 36 cents to settle at $106.04 a barrel. U.S. oil fell $1.06 to $96.43.
(Reporting by Herbert Lash, Additional reporting by Marc Jones; Editing by Chizu Nomiyama and Dan Grebler)