(Updates to midday)
By Denise Duclaux
NEW YORK, March 18 (Reuters) - Stocks wavered near unchanged in a shaky session on Tuesday, a day after a more than 3 percent rally, as worries over a tepid economy and war's unwelcome surprises took some luster off expectations for a swift U.S.-led strike on Iraq.
"Everything's got to go right for the market to keep rallying," said Todd Leone, head of listed trading at S.G. Cowen. "But I think everyone realizes the economy's still weak. I think the market is going to take a rest."
Iraqi President Saddam Hussein scorned an ultimatum by President George W. Bush giving him 48 hours to flee or face war. Some investors are waiting to see if an actual military strike on Iraq goes smoothly for the United States before pouring more money into the stock market.
Questions arose about the health of the U.S. economy after a report showing a tumble in U.S. housing starts last month. The Federal Reserve is expected to hold interest-rates steady in a statement released at about 2:15 p.m. (1915 GMT) but is seen shifting its risk assessment toward economic weakness
Major market gauges wobbled throughout the morning. The blue-chip Dow Jones industrial average rose 22 points, or 0.27 percent to 8,164. The broad Standard and Poor's 500 edged down 0.38 point, or 0.04 percent, to 862. The tech-laced Nasdaq Composite Index shed 3 points, or 0.22 percent, to 1,389.
"We had a really big move yesterday and some people are taking some partial profits, which is unsurprising," said Brian Belski, fundamental market strategist at US Bancorp Piper Jaffray. "Yesterday was a sign that war is going to happen and that was a big factor hanging over the market,"
The Dow is up 8 percent since the close last Wednesday when the gauge came close to touching multiyear lows. Last week's rise in the markets pushed the Nasdaq into positive ground for the year.
Declining stocks outpaced advancers by a ratio of 17 to 15 on the New York Stock Exchange and 8 to 7 on Nasdaq. More than 789 million shares changed on the Big Board and more than 864 million shares on Nasdaq in active trading.
TOBACCO STOCKS SLAMMED
Tobacco stocks were slammed after a New York Times report that the U.S. Justice Department, alleging a half-century of "fraudulent" and dangerous market practices, is demanding that the biggest U.S. cigarette makers be ordered to forfeit $289 billion in profits.
Altria Group Inc., a Dow component, sank $2.52, or more than 7 percent, to $32.20. R.J. Reynolds Tobacco Holdings Inc. sank $2.96, or 8 percent, to $33.73. UST Inc. dropped 73 cents, or almost 3 percent, to $27.36.
The S&P homebuilding index fell 1.56 percent after the disappointing report on housing starts. Centex Corp. slipped 79 cents to $51.81. KB Home fell 84 cents to $45.70. Pulte Homes Inc. dipped 69 cents to $49.35.
Ista Pharmaceuticals Inc. tumbled $1.91, or 29 percent, to $4.64. Although a Food and Drug Administration advisory panel said benefits of its drug to treat eye hemorrhages outweighs the risks, panel members questioned the quality of its clinical trials and the real effectiveness and safety of the drug.
Human Genome Sciences Inc. , a developer of gene-based drugs, rallied 97 cents, or more than 13 percent, to $8.15. The company said it was developing an immune system drug that could help thwart the effects of exposure to anthrax.
Consumer products maker Procter & Gamble Co. rose $1.23 to $86.73. The Dow member raised its quarterly profit outlook. The company also said it would take control of German hair care firm Wella in a $5.7 billion deal, giving P&G a boost against French rival L'Oreal .
Gateway Inc. fell 9 cents, or almost 4 percent, to $2.31. The No. 3 U.S. personal computer maker warned on Monday that its first-quarter results would fall far below analysts' forecasts and said it would slash its work force by 17 percent in a bid to cut annual costs by over $400 million.
(With additional reporting by Vivian Chu)