US STOCKS-Stronger dollar weighs on Wall Street

* Yahoo gains after WSJ reports AOL eyes tie-up

* Financial shares weigh

* Indexes: S&P off 0.4 pct, Dow off 0.5 pct, Nasdaq flat

* For up-to-the-minute market news see [STXNEWS/US] (Updates to early-morning trading)

By Edward Krudy

NEW YORK, Nov 8 (Reuters) - The Dow and S&P 500 fell on Monday after hitting two-year highs last week as a stronger dollar weighed on the market although the tailwinds of monetary easing and signs of a stronger economy capped losses.

The dollar has traded in a strong inverse relationship to U.S. equities recently. An unwinding of dollar short positions that began after solid U.S. jobs data last Friday gathered pace, while concerns over euro zone debt hurt the euro. The dollar rose 0.7 percent against a basket of currencies. <.DXY>.

U.S. stocks have risen for five straight weeks and surpassed levels not seen since before the Lehman Brothers bankruptcy. The rally has been helped by Republican gains in the U.S. midterm elections and the Federal Reserve's plans to buy $600 billion of government debt in a bid to reinvigorate a sluggish economic recovery.

Nicholas Colas, chief market strategist at the ConvergEx Group in New York, said the stronger dollar was weighing on equities after their recent strong run but added the underlying trend was still upward.

"We are still in an environment where the market is in an up trend," he said. "It's the quantitative easing, it's the hope for some continued better economic numbers like what we had from the Friday jobs report."

The Dow Jones industrial average <.DJI> dropped 58.39 points, or 0.51 percent, to 11,385.69. The Standard & Poor's 500 Index <.SPX> lost 5.08 points, or 0.41 percent, to 1,220.77. The Nasdaq Composite Index <.IXIC> dropped 0.12 points, or 0.00 percent, to 2,578.86.

Financial stocks were among the biggest losers, with the the S&P financial index <.GSPF> down 0.7 percent, weighed by Well Fargo & Co , which dropped 1.5 percent to $28.78 and State Street Corp , which fell 1.9 percent to $44.61.

Metals prices slipped as the dollar rose, while oil futures fell 0.6 percent toward $86 a barrel, easing from two-year highs earlier in the session. Gold was off for the first time in three sessions but remained near record highs. For details, see [ID:nN07170469]

Shares of Alcoa Inc , the largest U.S. aluminum producer, fell 1.4 percent to $13.81, while Exxon Mobil Corp eased 0.3 percent to $69.82.

In corporate news, AOL Inc is exploring strategic options, including a tie-up with Yahoo Inc , and has hired financial advisers, the Wall Street Journal reported, citing sources. Yahoo rose 1.2 percent to $16.46, while AOL added 1.3 percent to $25.25. [ID:nSGE6A7068]

McDonald's Corp fell 0.4 percent to $78.95 after it reported a weaker-than-expected rise in October sales at U.S. established restaurants as high unemployment plagued its key domestic market. [ID:nN08202623]

Helping the Nasdaq, Intel Corp added 1.1 percent to $21.48 after UBS raised the stock's rating to "buy" from "neutral" and estimated the semiconductors sector will see another couple of quarters of inventory adjustment globally. [ID:nWNAB0678]

The S&P 500 faces strong resistance at about 1,228, a key retracement of the benchmark's slide from its historic high in 2007 to the 12-year low in March 2009. (Reporting by Edward Krudy; editing by Jeffrey Benkoe)