The Fed acknowledged that the economy is still struggling to regain momentum, in a statement it released after its two-day policy meeting. The central bank said that growth had "paused in recent months," and while it was taking no new action, it would keep buying $85 billion of bonds a month.

"The Fed didn't really say anything out of the ordinary, so you got the reaction you should've had in the morning," said Joe Saluzzi a co-founder at brokerage firm Themis Trading. "When you've spent this much money trying to prop up an economy and you still come up with a negative print, that's bad news."

Still, stocks remain on track for a great January.

The Dow Jones average has surged 6.2 percent since the start of the year, climbing close to 14,000 and within touching distance of its record level. The S&P 500 has gained 5.3 percent this month, close to its highest level in more than five years. Investors bought stocks after lawmakers reached a deal to avoid the "fiscal cliff" and on optimism the U.S. housing market is recovering and the jobs market is slowly healing.

U.S. gross domestic product, the volume of all goods and services produced, contracted at an annual rate of 0.1 percent in the fourth quarter. That's a sharp slowdown from the 3.1 percent growth rate in the July-September quarter.

"To ignore this is folly," said Doug Cote, chief market strategist at ING Investment Management. "Certainly, this market could continue to move forward, but ignoring the fundamentals is not something I'd counsel my clients to do."

Positive company earnings reports helped offset the disappointing news about the economy and stem a bigger decline.