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Wall Street retreated Monday on concerns that Israel's attack on Gaza might disrupt oil production and shipments from the Middle East, driving oil prices higher.

Investors remained cautious in a holiday-shortened week, unwilling to make many big bets in the final three days of trading for 2008. Israel's escalating attacks against Gaza's Hamas rulers made traders more hesitant to buy.

The tensions pushed oil prices above $40 a barrel during the session, though crude was up just 37 cents at $38.03 a barrel on the New York Mercantile Exchange at midday. Oil has fallen more than $100 from its peak of $147.27 a barrel on July 11 as a slowing economy curbed demand.

Todd Leone, managing director of equity trading at Cowen & Co., said volume is extremely light and that is contributing to the market's swings. Low volume tends to skew price movements.

"What's going on in Israel didn't read well over the weekend," Leone said. "Beyond that, it is an incredibly quiet session. It's really not taking much to move the markets."

Investors also digested a potential blow to dealmaking on Wall Street. On Sunday, Kuwait's government canceled its $17.4 billion K-Dow Petrochemicals joint venture with Dow Chemical Co., saying it was "very risky" because of the global financial crisis and low oil prices. The joint venture was set to begin Thursday.

Rohm & Haas Co. maintains that its proposed $15.3 billion takeover by Dow Chemical won't be affected by Dow's substantial loss of income from the venture. But investors punished shares, driving them down $10.76, or 17 percent, to $10.76. Dow Chemical shares lost $3.89, or 21 percent, to $15.03.

In early afternoon trading, the Dow Jones industrial average fell 121.55, or 1.43 percent, to 8,394.00.

Broader indexes also declined. The Standard & Poor's 500 index fell 14.21, or 1.63 percent, to 858.59; the Nasdaq composite index fell 34.20, or 2.23 percent, to 1,496.04.

Declining issues were ahead of advancers by nearly 2 to 1 on the New York Stock Exchange, where volume came to 353.1 million shares.

Bond prices rose. The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 2.06 percent from 2.14 percent late Friday. The yield on the three-month T-bill, considered one of the safest investments, rose to 0.02 percent from 0.01 percent late Friday.

The dollar was lower against other major currencies, while gold prices edged higher.

Wall Street has largely written off the final three trading days of 2008, the worst year since Herbert Hoover was president. The Dow has fallen 36.2 percent, the biggest drop since 1931 when the Great Depression sent stocks reeling 40.6 percent. And the Standard & Poor's 500 index is set to record the biggest drop since its creation in 1957. The index of America's biggest companies is down 40.9 percent for the year.

Dave Rovelli, managing director of trading at brokerage Canaccord Adams, said investors will be waiting to make big moves until after the Jan. 20 inauguration of President-elect Barack Obama. Wall Street is eager for details on his proposed stimulus package for the economy.

"No one is going to do anything until the New Year," he said.

However, if companies release earnings warnings early in January, or if the first wave of fourth-quarter reports are disappointing, the market could see a return of heavy selling. Investors will be focusing on any word from companies deemed critical to the economy, especially from the beleaguered financial and retail sectors.

This week, investors will also be looking for insight into how retailers fared after the weak Christmas selling season. Stores have slashed prices even further to entice post-holiday shoppers but with many consumers nervous about the economy they're reluctant to open their wallets. That's a troubling prospect for investors, since consumer spending accounts for more than two-thirds of U.S. economic activity.

The Russell 2000 index of smaller companies fell 14.35, or 3.01 percent, to 462.42.

Overseas, Japan's Nikkei stock average rose 0.09 percent. In afternoon trading, Britain's FTSE 100 rose 2.44 percent, Germany's DAX index rose 1.63 percent, and France's CAC-40 rose 0.47 percent.

Copyright 2008 Associated Press. All rights reserved. This material may not be published broadcast, rewritten, or redistributed

Crude prices rose above $40 a barrel Monday as Israel and Palestinian militants exchanged rocket fire and the death toll mounted in the oil-rich region.

Light trading contributed to market volatility in the final days of 2008, with price swings of close to $5 a barrel.

Light, sweet crude for February delivery rose $2.31 cents to settle at $40.02 a barrel on the New York Mercantile Exchange, the first time crude has ended the day above $40 in a week. Nymex will be closed Thursday for the New Year's Day holiday.

Retail gasoline prices in the U.S. continued to fall and neared $1.60 per gallon nationally Monday.

In the Middle East, Israel destroyed symbols of Hamas power on the third day of what the defense minister described Monday as a "war to the bitter end." The three-day death toll rose to at least 364 on Monday, with some 1,400 reported wounded. Israel launched its campaign, the deadliest against Palestinians in decades, on Saturday in retaliation for rocket fire aimed at civilians in southern Israeli towns.

Israel obliterated symbols of Hamas power, with missiles striking next to the Hamas premier's home, and devastating a security compound and a university building.

Phil Flynn, an analyst at Alaron Trading Corp. in Chicago, called oil's initial run-up "an emotional reaction to what was going on in Israel," and said similar, short-lived spikes have occurred during other clashes in the region.

"In reality, the likelihood the conflict is going to interrupt oil supply in any way, shape or form is highly unlikely," Flynn said. "Obviously, if the conflict widens, and other countries get involved directly, you might have a different situation."

There were also hints from China the government could go on a crude-buying spree to take advantage of prices below $40 a barrel. A senior government official writing in the People's Daily said China wants to increase its oil reserves to cushion supply shocks that it believes are inevitable.

China is encouraging companies to use all spare petroleum storage capacity to take advantage of the current low prices, the official said.

Asia's biggest refiner, the state-owned China Petroleum & Chemical Corp., recently completed construction of its largest storage project, a 38-tank facility with a total capacity of 32.4 million barrels.

The Organization of Petroleum Exporting Countries, which accounts for about 40 percent of global supply, has announced crude production cuts totaling more than 4 million barrels per day as it tries to stop the decline in prices. OPEC members, however, have a history of ignoring announced quotas and crude traders are looking for evidence the 13-nation group is tightening the spigot.

In Vienna, JBC Energy, in its daily newsletter, said "the UAE has decided to reduce crude supplies in January and February in line with the OPEC production cuts." The United Arab Emirates are the fourth-largest producers in the 13-nation cartel.

Analysts at the U.S. firm Cameron Hanover noted Monday the UAE, unlike a number of other OPEC members, typically abides by planned cuts. "If OPEC countries actually cut all of the output they have agreed to cut, global supplies of crude will be tighter come spring," Cameron Hanover said.

Oil prices have fallen 73 percent since peaking at $147.27 a barrel on July 11 as a credit crisis in the U.S. sparked a steep drop-off in consumer demand and corporate earnings. Analysts expect more dismal economic news from the fourth quarter over the next few weeks.

"More bad profit reports, jobs reports, housing results will put pressure on prices," said Gerard Rigby, energy analyst with Fuel First Consulting in Sydney. "Once Obama comes in, that might start changing sentiment and generate more optimism." Barack Obama is scheduled to be sworn in as U.S. president Jan. 20.

Tumbling crude prices have led to enormous declines in the price of retail gasoline.

At the pump, retail gas prices fell eight-tenths of a penny overnight to a new national average of $1.619 a gallon Monday, well below the year-ago average of $3.039 a gallon, according to AAA and the Oil Price Information Service.

A Shell station in suburban Houston was selling regular unleaded for $1.19 a gallon on Monday.

In other Nymex trading, gasoline futures rose 3 cents to settle at 87.45 cents a gallon. Heating oil rose 4 cents to settle at $1.2853 a gallon, while natural gas for January delivery jumped 31 cents to settled at $6.136 per 1,000 cubic feet, well above the technically important $6 level.

In London, February Brent crude rose $2.18 to settle at $40.55 a barrel on the ICE Futures exchange.

Associated Press writers George Jahn in Vienna, Austria, and Alex Kennedy in Singapore contributed to this article.

Copyright 2008 Associated Press. All rights reserved. This material may not be published broadcast, rewritten, or redistributed