The S&P 500 fell more than 2 percent as surveys showed China's manufacturing sector shrinking at its fastest pace in three years and its services sector also cooling.

Oil prices initially fell more than 4 percent after rallying more than 8 percent yesterday.

"With the weak data coming out, we're going to see the negative sentiment from the last few weeks continuing," said Joe Rundle, a senior sales trader at ETX Capital.

The Dow Jones industrial average fell 359.91 points, or 2.18 percent, at 16,168.12. The Standard & Poor's 500 Index was down 41.64 points, or 2.11 percent, at 1,930.54. The Nasdaq Composite Index was down 79.94 points, or 1.67 percent, at 4,696.57.

Stocks added to losses after data showed U.S. factory activity hit a more than two-year low in August.

MSCI's all-country stock index lost 2.35 percent, while the pan European FTSEurofirst 300 stocks index was down 3.2 percent.

Asian stocks, particularly in Japan and Australia fell overnight, and the gloomy mood extended to Europe. The FTSEurofirst 300 dropped 3.2 percent, following its worst month in four years.

In the oil market, Brent crude dropped $3.24 to $50.91 a barrel. U.S. crude was down $3.10 at $46.10 a barrel. Yesterday it settled up $3.98, or 8.8 percent.

While shares and commodities remained the focus, the mood was similarly wary in the currency and bond markets.  

The safe-haven Japanese yen and the low-yielding euro both rose against the dollar, while a U.S. dollar index was down 0.1 percent.

Russia's rouble was among the hardest-hit emerging market currencies as the price of oil fell. 

FRAGILE CHINA

The head of the International Monetary Fund, Christine Lagarde, summed up the situation in a speech in Indonesia, where she said global economic growth was now likely to be weaker than had been expected just a few months ago.

She cited both a slower recovery in major advanced economies and a further slowdown in emerging nations and highlighted the need to "be vigilant for spillovers" from China's stutters.

Comments by Federal Reserve Vice Chairman Stanley Fischer over the weekend appeared to keep alive chances of a U.S. interest rate increase in September.

Spot gold rose to a session high of $1,147.16 an ounce and was up 0.9 percent at $1,144.42 an ounce.

London Metal Exchange copper fell almost 1 percent to $5,087.50 as markets reopened after a long holiday weekend. Nickel slid 2 percent and aluminium skidded as well.