Small-cap stocks reversed course Thursday, pulling back into the recent range as the credit crisis moved to the forefront, punishing financial stocks. The selling mood was also stirred by soft economic data and worries about consumer spending after sluggish sales at benchmark retailer Wal-Mart Stores (NYSE:WMT). In the end, the Russell 2000 (NYSE:IWM) shed 12.48, or 1.72%, to 713.42.

Large-cap financial stocks were getting hammered in the afternoon today, extending a gloom that began after Wednesday’s close when insurance giant American International Group (NYSE:AIG) reported hefty quarterly losses amid write-downs of bad mortgage loans. The whole mess with AIG rekindled fears about the credit crunch and investors dumped shares in a wide swath of financial names. AIG tumbled some 18% on the day. The nation’s top bank, Citigroup Inc. (NYSE:C) stumbled amid news that the firm would buy back some $7 billion in auction-rate securities and pay a $100 million civil fine to settle a suit that it misled investors on the risk of the investments. Citigroup lost about 6% on the day. Merrill Lynch & Co. (NYSE:MER) lost 8%, Lehman Bros. Holdings, Inc. (NYSE:LEH) tumbled 13%, JP Morgan Chase Co. (NYSE:JPM) was down 4% and mortgage finance firms Fannie Mae (NSE:FNM) and Freddie Mac (NYSE:FRE) were down 14% and 9%, respectively. The Financial Select SPDR was down 5%--and it’s not as if those declines are limited to the large-cap banks and brokerage houses. There are dozens of small- and mid-cap banks out there, and they have even more trouble accessing credit during the crunch than the big firms.

As you might expect, financial themes dominated the worst performing sectors today, with insurance shares, thrifts and mortgage finance firms taking a big hit, followed by regional banks, diversified banks, investment banks, custody banks, diverse financial services firms, hypermarkets, and airlines all getting clobbered. The best performing sectors today were wireless telecoms and semiconductor shares, which helps explain why the tech-laden Nasdaq 100 was down less than other index products.

In addition to the financial worries, same-store sales figures for WMT missed the forecast, and even some of those that looked good – such as Costco Wholesale Corp. (Nasdaq:COST) –  were inflated by a jump in gasoline prices. For the day, WMT was off about 6%, while COST was up 0.4%. Target Corp. (NYSE:TGT) slumped 4%. Among small-cap stores, Bon Ton Stores Inc. (Nasdaq:BONT) was down 13%, Hot Topic Inc. (Nasdaq:HOTT) was down 10% and Jo-Ann Stores (NYSE:JAS) was down 5%.

Other individual small-caps of note Thursday included Perficient Inc. (Nasdaq:PRFT), which tumbled 28% on sloppy earnings. inVentive Health Inc. (Nasdaq:VTIV) dropped 20% as the firm lowered guidance for 2008. VTIV shares also traded on unusually heavy volume during the day. The bearish earnings bug bit Emergent BioSolutions Inc. (NYSE:EBS), which plunged 24% after quarterly results failed to impress investors. On the bright side, Noble International Ltd. (Nasdaq:NOBL) soared 69% after earnings news
 
In addition to the credit crisis concerns and mixed-to-soft same-store results, there was little relief on the economic front as well. Although pending home sales were better than expected, they were overshadowed by another jump in weekly unemployment claims, which showed last week’s shocking number was not a fluke by climbing to the highest level in more than six years. If unemployment is on the upswing, the Fed won’t be able to fight inflation via higher interest rates, and consumer spending – which accounts for about two-thirds of the economy – probably won’t be robust.

Even crude oil prices added a little salt in the bulls’ wounds today, climbing $1.44 dollars a barrel back above $120 as supply disruptions in the Middle East and out of Africa halted the recent collapse in energy prices. A major pipeline in Turkey that accounts for some one million barrels of crude a day (roughly 1% of production) is on fire and could be out of commission for several more days. In Nigeria, rebel forces continue to be a threat to production from that key area.

Despite the upside pop in crude oil, the U.S. dollar pushed higher against the euro, climbing about 0.4% to the highest point since March. The greenback was down about 0.4% against the yen, however, taking a breather after surging to 7-month highs Wednesday.

The sharp pullback in small-cap stocks today meant that the market was unable to break free of the recent range, after coming tantalizingly close during Wednesday’s big rally. It will take decisive action above 726 in coming days to validate any upside breakout. For now, the market is still searching for the right kind of news to jolt the bears out of their comfort zone. If the market can mount a convincing push through either 726 on the upside, or 694 on the downside, it would carry a target move of 32 handles, which would be a big event. Looking ahead to Friday’s action, it would probably take a surprise outside of the economic data world to spark such a move, as the morning reports on productivity and wholesale inventories seldom pack much of a punch.