Stocks erased a brief rally and turned sharply lower Monday, after a weak manufacturing report resurfaced concerns about a slowing economy.

The Dow Jones industrial average tumbled 128 points, or 1.1%, after being up as much as 139 points earlier in the session.

Home Depot and Merck were the biggest laggards on the blue chip index, with shares falling 3%.

The S&P 500 slid 15 points, or 1.2%, and the Nasdaq composite lost 33 points, or 1.2%.

While investors showed early enthusiasm for the debt ceiling deal, which still needs Congressional approval, they quickly moved past it to refocus on the fragile U.S. economy.

"We keep seeing data that shows the economy is getting worse," said Kim Caughey Forrest, senior equity analyst at Fort Pitt Capital Group. "Earlier this year, we thought the economy would improve -- albeit gradually. But all the negative surprises are concerning investors."

Last Friday's second-quarter GDP report in particular served as a stark reminder that the economy is growing at a sluggish 1.3% pace.

The gloom continued into Monday, with a report that showed that the manufacturing sector nearly stood still in July. The Institute for Supply Management's manufacturing index slid to 50.9 in July -- much worse than the 54 that economists were expecting, and down from 55.3 in June.

Stocks posted their worst weekly performance in more than a year last week, losing $700 billion in market capitalization.

America's debt crisis: Obama announced late Sunday that lawmakers reached a deal to raise the debt ceiling and dramatically curb federal spending -- and avoid a costly default in the end.

But the president cautioned that lawmakers' work was not done, with the deal expected to go up for votes Monday.

Investors are also still grappling with the possibility that the United States' credit rating could get downgraded.

"Eventually there's a downgrade coming, it depends on Moody's, S&P and Fitch and they're very slow-moving," PIMCO founder and managing director Bill Gross told CNN Sunday. "This country has $10 to 12 trillion worth of outstanding debt. In addition, however, we've got about $60 trillion worth of liabilities. I call this Debt Man Walking."

Economy: The job market remains one of the roughest spots in the economic recovery, and investors will be bracing for the all-important July jobs report due Friday.

The U.S. economy is expected to have created 78,000 jobs last month, according to a consensus of analysts polled by Briefing.com. In June, the economy added a paltry 18,000 jobs.

"We're 25 months into the recovery, and the job market is moving in the right direction but it's still abysmal," said Mark Luschini, chief investment strategist at Janney Montgomery Scott. "If the figures on Friday come below estimates, that will only compound economic concerns and lift the probability of the economy falling back into a recession."

Companies: Shares of HSBC Holdings PLC rose 1%, after the London-based bank announced it will eliminate 25,000 jobs by 2013. The bank has already trimmed 5,000 jobs. The job cuts are seen as a positive, since they help the bank reduce costs. HSBC also posted a solid profit.

Shares of defense firms slipped, since the debt deal includes about $2.4 trillion in spending cuts that would hurt major government contractors.

Northrop Grumman's stock sank 2.5%, while shares of Lockheed Martin, Raytheon and General Dynamics also declined.

World markets: European stocks also drifted into the red in afternoon trading and ended lower. Britain's FTSE 100 fell 0.7%, the DAX in Germany dropped 2.8% and France's CAC 40 sank 1.9%.

Asian markets ended the session with gains, with Tokyo's Nikkei leading the rally, after Obama announced the debt deal. The Shanghai Composite edged higher 0.1%, the Hang Seng in Hong Kong rose 1% and Japan's Nikkei climbed 1.3%.

Currencies and commodities: The dollar rose against the euro and British pound, but was flat versus the Japanese yen.

Oil for September delivery fell $1.56 to $94.14 a barrel.

Gold futures for December lost rose $1.40 to $1,632.60 an ounce.

Bonds: The price on the benchmark 10-year U.S. Treasury edged higher, pushing the yield down to 2.73% from 2.80% late Friday. Read More