The stock market lost its footing this week, and Goldilocks seemed to fall into a ditch.

After more than seven months of rallying, the U.S. stock market experienced a panic-ridden day — Tuesday — not seen since the immediate aftermath of the Sept. 11, 2001, terrorist attacks. The three major indices had their worst week since March 2003.

The main culprit? China’s stock market. Its near-130% surge last year was one of the prime examples of investors ramping up leverage to take on more risk.

Investors awakened Tuesday to an 8.8% plunge in China’s Shanghai Composite index, and the selling began. Margin calls kicked in and begat more selling. As the week progressed, the vehicles that offered investors the opportunity for those leveraged bets, such as the Japanese yen carry trade (borrowing yen at a paltry 0.5% and investing in higher-yielding assets elsewhere), unwound as volatility increased.

After choppy sessions following Tuesday’s rout, the Dow Jones Industrial Average closed down 4.2% for the week, 1% on Friday alone, to 12,114.10. The S&P 500 slid 4.4% on the week and 1.1% Friday, and the Nasdaq Composite fell 5.8% this week and 1.5% Friday, closing at 2368.00.

The price of crude oil jumped 1.2% this week to $61.64 per barrel, while gold slid 6.4% to $644.10 per ounce. The Treasury bond market rallied sharply as investors took the “flight to safety” route. The yield on the 10-year note fell to 4.51% Friday from 4.68% last week. The value of the yen rose 4% vs. the dollar.

In overseas markets, the Shanghai Composite recaptured some of its losses, sliding just 6.8% on the week. Japan’s Nikkei 225 slid 5.3%. The weakness overseas wasn’t limited to Asia. The broad MSCI Emerging Markets Index fell 8.1% for the week.

Within the U.S., stock market declines were broad-based even as some investors started to look for bargains. Traders mentioned dipping into housing stocks and even some of the subprime mortgage lenders, hoping the worst was over. But given that the indices ended Friday’s trading session at the day’s lows, hopes for a stock market bottom were dim.

“Never on a Friday,” says Jeffrey Saut, chief equities strategist at Raymond James & Co. “Markets never bottom on a Friday after a week like this. Participants go home and brood about it.” Saut believes there may be a “tradeable low” on Monday or Tuesday, but that would just lead to a three-to-five-day “throwback rally.”

Overall, “the consternation isn’t over,” he says. “The market had a heart attack, and a heart attack patient doesn’t get right off the gurney and run the 100-yard dash. The market shouldn’t either.”

Only two Dow stocks were in the green Friday as declines of more than 2% each in General Motors (GM) , Citigroup (C) and JPMorgan Chase (JPM) led the index south. Merck (MRK) was up a fraction, and American International Group (AIG) jumped more than 3% on a strong earnings report.

The financial sector and banks were particularly weak, as those companies struggled amid subprime meltdown woes and recession fears. After seeming nearly unbreakable for several months, the mighty were falling. Goldman Sachs (GS) lost 9.6%. Merrill Lynch (MER) , Bank of America (BAC) and JPMorgan Chase fell 7.7%, 5.4% and 5.6%, respectively.

The bottom was decidedly not in for the subprime mortgage lenders either. Shares of Countrywide Financial (CFC) , New Century Financial (NEW) and Accredited Home Lenders (LEND) slid more than 4% each on the week.

Investors looked to economic data to inspire a bounce or fuel more selling. They found germs of worry in several reports and in some of the rhetoric that swirled through Wall Street’s corridors.

Ex-Federal Reserve Chairman Alan Greenspan agitated by mentioning the possibility of a recession. Then current Fed Chairman Ben Bernanke soothed by saying that after he watched the recent data, there was no material change to his economic outlook.

The data were mixed.

On the strong side, personal income and spending rose higher than expected, and the Institute for Supply Management’s manufacturing index jumped to a 52.3 reading vs. expectations for a flat 50 reading.

But manufacturing and business spending looked exceptionally weak, with a dismal decline of 7.8% in durable goods orders. The Commerce Department also revised fourth-quarter GDP to 2.2% from initial estimates of 3.5%. One of the biggest downward revisions was to business investment spending. The Chicago PMI report, which chronicles manufacturing activity in the Midwest, was weak at 47.5 — a reading that indicates contraction in the economy.

Perhaps the most disturbing piece of data was the initial jobless claims, which came in higher than expected for the third consecutive week. The four-week moving averages of initial and continuing claims rose to their highest levels since after Hurricane Katrina, in August 2005.

“The longer the uptrend continues, the more likely the move is significant,” wrote Joe Lavorgna, chief economist at Deutsche Bank. Lavorgna revised his forecast for payrolls down to 75,000 from the consensus 100,000 estimate.

Indeed, all eyes will be on the payrolls report next week. If unemployment starts to rise, the Fed gets back in the game with a possible rate cut. That may be something traders think they want after such a panic-stricken week, but it surely would accompany a shift to a much weaker economy, which does not actually bode well for profits or stocks in the near term.

1 What would best describe your stance heading into the coming week of trading?

Bullish
Bearish
Neutral

2 Which of these sectors do you think is set to move up in the coming week?

3 Which of these sectors do you think is set to move down in the coming week?