U.S. stocks fell Friday after a manufacturing index showed its weakest reading in more than three years and a Federal Reserve official said more rate hikes may be required to control inflation.

The Dow Jones industrial average fell 27.80 points, or 0.23 percent, to 12,194.13, while the Standard & Poor's 500 Index dropped 3.92 points, or 0.28 percent, to 1,396.71. The Nasdaq Composite Index sank 18.56 points, or 0.76 percent, to 2,413.21.

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But the Dow, the S&P 500 and the Nasdaq slashed earlier losses — the Dow and the S&P were briefly down more than 1 percent and the Nasdaq was off nearly 1.5 percent — at the end of the session as investors bought up shares they considered inexpensive after the brisk sell-off.

The Institute for Supply Management's manufacturing index unexpectedly fell below 50 in November, showing a shrinking sector. The news hurt shares of big manufacturers such as those of 3M Co. (MMM) and Caterpillar Inc. (CAT), making them the top negative weights on the Dow.

The ISM's report confirmed worries about a slowdown after Thursday's surprising Chicago PMI news showing business activity contracted in the Midwest.

Michael Moskow, the president of the Federal Reserve Bank of Chicago, added to the market's woes after he said further tightening of monetary policy may be required to bring down remaining inflationary pressures.

"ISM came in and echoed the sentiment of the Chicago PMI. The sub-50 (reading) got everybody upset and prices paid were higher as well, which showed a bad combination of contracting growth and inflation," said Larry Peruzzi, senior equity trader at The Boston Co. Asset Management.

For the week, stocks fell — marking the first back-to-back weekly losses for the Dow and the S&P 500 since July. The Dow finished the week down 0.7 percent, while the S&P 500 shed 0.3 percent.

The Nasdaq lost 1.9 percent, its biggest weekly percentage decline since mid-July.

The Nasdaq's drop Friday came after shares of Advanced Micro Devices Inc. (AMD), the No. 2 computer chip maker, and graphics chip maker Nvidia Corp. (NVDA) fell around 4 percent as the companies said they had been subpoenaed in a U.S. antitrust investigation.

Adding to the Nasdaq's woes, the stock of Intel Corp. (INTC), the world's biggest chip maker, dropped 2.2 percent, or 46.5 cents, to $20.93 on news that rival AMD was on track to launch a new chip by mid-2007.

Further weighing on the Nasdaq were shares of the market's parent, Nasdaq Stock Market Inc., which fell 7.1 percent, or $2.83, to $37.32 after Prudential Equity Group LLC downgraded the largest U.S. electronic exchange to "underweight" from "overweight."

Shares of 3M Co. fell 1.8 percent, or $1.48 and contributed the most to the Dow's decline. The second-biggest drag on the Dow was Caterpillar Inc., whose stock dropped 1.4 percent, or 84 cents, to $61.19 on the New York Stock Exchange.

Shares of Nvidia tumbled 3.9 percent, or $1.45, to $35.54 on the Nasdaq and AMD shares slid off 4.1 percent, or 88 cents, to $20.69 on the NYSE.

Among gainers, shares of Home Depot Inc. (HD) rose 2.6 percent, or $1.00, to $38.97 on the NYSE after media reports of possible buyout interest in the world's largest home improvement retailer. But Chief Executive Robert Nardelli, quoted by the Atlanta Journal-Constitution, denied Home Depot was pursuing any such deal.

Volume was active on the NYSE, where about 1.72 billion shares changed hands, exceeding last year's daily average of 1.61 billion. On Nasdaq, about 2.04 billion shares traded, above last year's daily average of 1.80 billion.

Decliners outnumbered advancers on the NYSE by a ratio of about 6 to 5, while on Nasdaq, more than nine stocks fell for every two that rose.

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