Stocks retreated below key levels Monday as the economic optimism stoking a big rally in recent weeks ebbed, compelling investors to skim some gains off the market's 20 percent rise.

The blue-chip Dow Jones industrial average sank 127.80 points, or 1.27 percent, to 9,921.66, while the Nasdaq composite shed 29.02 points, or 1.44 percent, to 1,992.24. The benchmark Standard & Poor's 500 fell 18.40 points, or 1.59 percent, to 1,139.91.

Trading lacked conviction ahead of the Federal Reserve's final policy-setting meeting of the year. The central bank is expected to cut key interest rates for the 11th time this year, bringing them to levels unseen since the 1960s.

"I guess everybody is waiting for (Fed Chairman) Alan Greenspan," said Lance Zipper, managing director of equity trading at Brean Murray & Co. "But the decision comes out and everybody interprets it a little bit differently."

"The market recovered very rapidly and right now I would consider this to be more of a consolidation rather than a retreat,'' said Stanley Nabi, managing director at Credit Suisse Asset Management, which oversees $100 billion in North American. "I think we have made the lows, and we are in a market that is in measured recovery.''

The Federal Reserve is expected to shave another quarter percentage point off key interest rates on Tuesday and drop them to levels not seen since the 1960s.

Hopes for a U.S. recovery in 2002 have hoisted the market well off three-year lows hit on Sept. 21, even though economic activity has contracted sharply. Most stock indices are up 20 to 40 percent from this year's lows.

Although the Nasdaq plunged below 2,000, it remains more than 40 percent above the three-year lows it hit on Sept. 21. The Dow pierced the 10,000 mark last week for the first time in three months and has rallied more than 20 percent since late September.

The future of a planned merger between computer giants Compaq Computer Corp. and Hewlett-Packard Co. weighed on Wall Street, but investors nibbled at stocks like semiconductors and airlines on hopes the battered industries will get a lift next year.

Compaq fell $1.62 to $9.70, while H-P lost 52 cents to $23. The largest single shareholder in HP will oppose the proposed $25.2 billion merger, a major setback analysts said could kill the deal. 

Compaq's future as a stand-alone company will be staked once again to the downtrodden personal computer business if its merger with H-P is scuttled, fear of which could weigh on its stock in the coming days, analysts said. 

Enron Corp., the once mighty energy trader that filed for the biggest bankruptcy in U.S. history, gained 9 cents to 84 cents. UBS Warburg, the investment banking arm of Swiss bank UBS AG is preparing a bid for Enron's trading operations, and JP Morgan Chase & Co. and Citigroup may also make offers, according to a source.

Citigroup slipped 84 cents to $48.37, while JP Morgan lost $1.03 to $38.74. Both weighed on the blue-chip Dow.

Retailing and financial sectors also suffered on worries that the sluggish economy would continue to hurt business for a while. Home Depot dropped $1.15 to $48.26, while American Express fell 70 cents to $34. 

Even news that General Electric expected to expects to achieve double-digit earnings growth next year failed to cheer investors. GE dropped 35 cents at $36.80.

Halliburton, the oilfield services and engineering giant once headed by Vice President Dick Cheney, recovered from Friday's steep loss. The stock bounced $2.19 to $14.19 and was the most active on the New York Stock Exchange. The company reiterated it does not expect asbestos injury claims to have a significant financial impact.

Newmont Mining Corp. fell 93 cents to $19.09 after the U.S. gold miner sweetened its bid for Australian mining concern Normandy Mining Ltd.

The Philadelphia Stock Exchange Semiconductor index lost 0.78 percent after surging 50 percent since Sept. 21. Chip designer Xilinx Inc. rose $1.02 to $42.02 after Morgan Stanley raised its price target on expectations of solid revenues.

JDS Uniphase Corp. lost 61 cents at $9.92 and was one of the most active on Nasdaq. The company expects lower quarterly sales as the industry-wide downturn shows no signs of easing.

Telephone and cable television giant AT&T Corp. lost 67 cents to $17.01 and weighed on the Dow. The company has not decided on the fate of its cable TV unit, and will continue discussions with all suitors interested in buying or investing in the U.S. cable television company.

But the main focus of the market was on the Fed meeting scheduled for Tuesday, and what many hope will be the 11th interest rate reduction of the year. 

The cut is widely expected, although there is some debate over how big it will be. There is also some thought that the reduction could be the Fed's last because rates are already at a 40-year low and companies including Cisco and Oracle have issued relatively upbeat forecasts. 

In any case, investors were unwilling to make any big moves before the Fed's decision. 

"People are waiting to see what the Fed does and what their tone is,'' said John Forelli, portfolio manager for John Hancock Core Value Fund. ``My guess is that their tone will be that they will continue to cut rates if necessary. To some degree, that's already factored in stock prices, but I think the market will still be pleased.'' 

Declining issues led advancers more than 2 to 1 on the New York Stock Exchange, where volume came to 1.18 billion shares, down from Friday's 1.24 billion. 

The Russell 2000 index fell 7.03 to 474.18. 

Overseas, Japan's Nikkei stock average dropped 2.1 percent. In Europe, Germany's DAX index fell 1.4 percent, Britain's FT-SE 100 slipped 1.5 percent, and France's CAC-40 lost 1.9 percent.

Reuters and the Associated Press contributed to this report.