North American markets fell Monday and U.S. stocks had their worst drop in more than three months as the prospect of political paralysis in Italy raised the specter of Europe's debt crisis flaring up again.

In Toronto, the S&P/TSX composite index came down from a 130-point jump to close down 50.76 points to 12,650.87.

In New York, the Dow Jones industrial average fell 216.40 points, or 1.6 per cent, to 13,784.17, its biggest drop since Nov. 7.

The Standard & Poor's 500 index fell 27.75 points, or 1.8 per cent, to 1,487.85, dropping below 1,500 for the first time in three weeks.

The Nasdaq composite dropped 45.57 points, or 1.4 per cent, to 3,116.25.

Stocks had rallied in the early going as exit polls showed that a center-left coalition in Italy that favored economic reforms in the euro region's third-largest economy was leading.

That gain evaporated after a later poll predicted that the elections could result in a stalemate in the country's legislature.

Market confidence 'imploded'

The losses accelerated in the late afternoon as partial official results showed an upstart protest campaign led by a comedian making stunning inroads.

"There was confidence in this election and obviously confidence imploded," said Ben Schwartz, a market strategist at Lightspeed Financial.

Investors dumped Italian government bonds, sending their yields higher, and erased most of an early rally in Italy's stock market. The yield on Italy's 10-year government bond shot up to 4.43 per cent from 4.12 percent early in the day, a sign that investors' confidence in Italy's government was dimming quickly.

The country's benchmark stock index, the FSTE MIB, rose 0.7 per cent, giving up an early gain of four per cent. Investors worry about the outcome of Italy's election because it could set off another crisis of confidence in the region's shared currency, the euro.

Financial markets in both Europe and the U.S. have swooned at the prospect of Italy or Spain being dragged into the region's government debt troubles, which have led to bailouts of Greece, Ireland and Portugal and severe disruptions in financial markets.

As stocks plunged, gauges of market sentiment indicated that investors were becoming more risk-averse and parking their money in defensive assets.

The yield on the 10-year Treasury note, which is widely considered an ultra-safe investment, fell sharply as investors plowed money into U.S. government bonds. The yield fell to 1.88 per cent from 1.96 per cent late Friday.

The VIX index, a measure of how volatile investors expect the stock market to be, surged 34 per cent to 19, the biggest one-day move since August 2011.

With files from The Canadian Press