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US STOCKS-Wall St drops after surprise rise in jobless claims, stimulus impasse

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* Walgreens rises on 2021 profit growth forecast

* CBOE volatility index hits one-week high

* Weekly jobless claims unexpectedly rise in latest week

* Indexes down: Dow 0.49%, S&P 0.80%, Nasdaq 1.28% (Adds comment, details; Updates prices)

Oct 15 (Reuters) - U.S. stocks dropped on Thursday as an unexpected rise in weekly jobless claims compounded fears of a stalling economic recovery against the backdrop of dimming hopes for more fiscal aid before the election.

Initial claims for state unemployment benefits totaled a seasonally adjusted 898,000 for the week ended Oct. 10, compared to 845,000 in the prior week, the Labor Department said on Thursday. Economists polled by Reuters had forecast 825,000 applications in the latest week.

A separate report showed manufacturing activity in New York State fell more than expected in October.

“Going into the fall it will be difficult for unemployment to make a lot of positive headway because of the lack of stimulus,” said Christopher C. Grisanti, chief equity strategist, MAI Capital Management in Cleveland.

A day after Treasury Secretary Steven Mnuchin said a deal on more federal aid was unlikely before the Nov. 3 presidential election, President Donald Trump said there was still a chance.

The CBOE volatility index, investors’ fear gauge, hit a one-week high and Wall Street’s indexes fell for the third straight day. The S&P 500 is now nearly 4% below its intraday record high hit on Sept. 2, after rising to within 1% of that level earlier this week.

With less than 20 days to Election Day, Trump and Democratic challenger Joe Biden will hold dueling prime-time town halls on Thursday instead of their second presidential debate, which was canceled after Trump declined to take part in a virtual matchup.

Focus is also on the quarterly results for corporate America, with expectations for third-quarter earnings improving to an 18.8% drop from a 25.0% tumble forecast on July 1, according to Refinitiv IBES data.

Morgan Stanley edged 1.5% higher after it beat third-quarter profit estimates, winding up mixed results from major U.S. lenders. The earnings reports saw those focused on trading clocking big gains, while retail banks took a hit from the COVID-19 pandemic.

Financial stocks added 0.2%, while communication services and technology shares posted the steepest losses among S&P sectors.

At 12:35 p.m. ET, the Dow Jones Industrial Average was down 140.43 points, or 0.49%, at 28,373.57, the S&P 500 was down 27.98 points, or 0.80%, at 3,460.69. The Nasdaq Composite was down 151.04 points, or 1.28%, at 11,617.69.

Walgreens Boots Alliance Inc gained 2.7% as the drugstore chain forecast profit to grow in single digits in 2021 after reporting a better-than-expected fourth-quarter profit.

The S&P 1500 airlines index shed 2.2% as United Airlines reported a 78% drop in quarterly revenue.

Shares of drug developer Vertex Pharmaceuticals Inc sank 20.2% after it discontinued its trial of a protein deficiency disorder treatment.

Declining issues outnumbered advancers for a 1.81-to-1 ratio on the NYSE and for a 1.82-to-1 ratio on the Nasdaq.

The S&P index recorded two new 52-week highs and no new low, while the Nasdaq recorded 31 new highs and 26 new lows. (Reporting by Medha Singh and Shivani Kumaresan in Bengaluru; Editing by Shounak Dasgupta)