Wall Street falls on Russia probe, but tax hopes soften blow

By Lewis Krauskopf

(Reuters) - Wall Street fell on Friday after an ABC News report that President Donald Trump's former national security adviser was prepared to testify that before taking office Trump had directed him to make contact with Russians.

But major Wall Street indexes recouped much of their initial losses, after U.S. Senate Republicans said they had enough support to pass a sweeping tax overhaul.

The Senate news was the latest sign of progress for a tax bill being closely watched by investors, with hopes that significant corporate tax cuts will further fuel Wall Street's record-setting rally.

The benchmark S&P 500 was down as much as 1.6 percent following the report involving former U.S. national security adviser Michael Flynn. Flynn pleaded guilty on Friday to lying to the FBI about Russia.

"This Flynn thing threw everything for a loop. We had that still against the backdrop of tax reform," said J.J. Kinahan, chief market strategist at TD Ameritrade in Chicago.

"We are at all-time highs so sometimes when you do get news that's of a nature where people want to sell, it gets a little bit overdone," Kinahan said.

The Dow Jones Industrial Average fell 92.79 points, or 0.38 percent, to 24,179.56, the S&P 500 lost 12.38 points, or 0.47 percent, to 2,635.2 and the Nasdaq Composite dropped 48.21 points, or 0.7 percent, to 6,825.77.

Steep sell-offs have been a rarity on Wall Street this year. The S&P 500 has closed down by at least 1 percent only four times in 2017.

Progress with the tax legislation in the Senate had helped buoy stocks this week, as well as drive a rotation into those areas that seem poised to benefit from lower corporate taxes.

The S&P has rallied some 18 percent this year, boosted by solid global economic data and strong U.S. corporate earnings. But with investors optimistic about some aspects of Trump's domestic agenda, especially tax cuts, news involving his administration has periodically rattled markets.

"We've kind of gotten used to the drama in the White House," said Rob Stein, CEO of Astor Investment Management in Chicago. "Whether or not they prove that there are Russian relationship ties, that doesn't have a long-term effect on the value of the stock market."

Energy <.SPNY> was the best-performing sector, rising 0.6 percent. Crude futures rose a day after OPEC and other major producers agreed to continue reining in output until the end of 2018 to try to reduce a global oil glut and boost prices.

Declining issues outnumbered advancing ones on the NYSE by a 1.28-to-1 ratio; on Nasdaq, a 2.17-to-1 ratio favoured decliners.

(Additional reporting by April Joyner in New York and Sruthi Shankar in Bengaluru; editing by Bernard Orr and Chizu Nomiyama)