The ISM non-manufacturing index came in at 52.6 for September, below the 55.3 that economists surveyed by Dow Jones were expecting. While the sector is still expanding, the reading marked a sizable drop from the 56.4 print for August. Any reading below 50 is a sign the sector is contracting.
Early selling had the Dow Jones Industrial Average down more than 320 points, or 1.2 percent. The S&P 500 and Nasdaq were both lower by 1 percent. The early selling had pushed the Dow's loss for the fourth quarter, which began on Tuesday, to more than 1,100 points.
The disappointing services data came one day after weaker-than-expected U.S. manufacturing and hiring data fueled jitters about the global economy.
Adding to the uncertainty was a World Trade Organization ruling that cleared the United States to impose tariffs on up to $7.5 billion of European goods to compensate for illegal subsidies given to aircraft manufacturer Airbus. The Trump administration said tariffs would begin Oct. 18.
Shares of the electric-car maker Tesla were under pressure after third-quarter deliveries fell short of expectations. Tesla said it delivered 97,000 vehicles during the quarter, just shy of the 99,000 that was expected.
On the earnings front, Bed Bath & Beyond was lower after reporting mixed second-quarter results and said that it was closing 60 more stores as its turnaround has struggled to take hold.
Meanwhile, PepsiCo shares gained after the beverage and snack maker said its aggressive advertising campaign propelled it to better than expected third-quarter results.
Elsewhere, GoPro plunged after slashing its earnings and revenue forecasts for the back half of the year. The action-camera maker cited production delays for the latest Hero8 Black cameras are cited as the reason.
In Europe, the major averages traded mixed. German markets were closed for a holiday.
In Asia on Thursday, Japan's Nikkei fell 2 percent and Hong Kong’s Hang Seng lost 0.3 percent. Chinese and Korean markets were closed for a holiday.
Ken Martin and the Associated Press contributed to this article.