Mr Kerry said the prospect of a peace deal based on a two-state solution was in grave jeopardy.
Israeli settlement building on occupied land was a major problem, he said.
Mr Netanyahu said he was disappointed with the speech, which he said was "unbalanced" and "obsessively focused" on settlements.
Mr Kerry had "paid lip service to the unremitting Palestinian campaign of terrorism" against Israel, he said.
He added that the conflict centred on the Palestinians' refusal to recognise Israel's right to exist, but Mr Kerry "does not see the simple truth".
Earlier, US President-elect Donald Trump tweeted in support of Israel, saying he would not allow it to be treated with "disdain and disrespect".
He urged Israel to "stay strong" until he assumed office next month.
On Friday, the US chose not to veto a UN Security Council resolution calling for an end to Israeli settlement construction, leading to an angry response from Israel.
The issue of Jewish settlements is one of the most contentious between Israel and the Palestinians, who see them as an obstacle to peace and the creation of a viable Palestinian state.
More than 500,000 Jews live in about 140 settlements built since Israel's 1967 occupation of the West Bank and East Jerusalem. The settlements are considered illegal under international law, though Israel disputes this
What is the two-state solution?
A "two-state solution" to the decades-old conflict between Israelis and Palestinians is the declared goal of their leaders and many international diplomats and politicians.
It is the shorthand for a final settlement that would see the creation of an independent state of Palestine within pre-1967 ceasefire lines in the West Bank, Gaza Strip and East Jerusalem, living peacefully alongside Israel.
The United Nations, the Arab League, the European Union, Russia and the United States routinely restate their commitment to the concept.
In his speech, Mr Kerry said that despite Israeli claims to the contrary, UN condemnation of illegal Jewish settlements on occupied land was in line with American values.
"The two-state solution is the only way to achieve a just and lasting peace between Israelis and Palestinians. It is the only way to ensure Israel's future as a Jewish and democratic state. That future is now in jeopardy," he said.
He added: "The Israeli prime minister publicly supports a two-state solution, but his current coalition is the most right-wing in Israeli history with an agenda driven by the most extreme elements.
"The result is that policies of this government, which the prime minister himself just described as more committed to settlements than any Israel's history, are leading in the opposite direction. They are leading towards one state."
In two tweets issued on Wednesday, Mr Trump said: "We cannot continue to let Israel be treated with such total disdain and disrespect.
"They used to have a great friend in the US, but... not anymore. The beginning of the end was the horrible Iran deal, and now this (UN)! Stay strong Israel, January 20th is fast approaching!"
Mr Netanyahu replied on Twitter: "President-elect Trump, thank you for your warm friendship and your clear-cut support for Israel!"
The UN resolution passed last Friday stated that the establishment of settlements "has no legal validity and constitutes a flagrant violation under international law and a major obstacle to the achievement of the two-state solution and a just, lasting and comprehensive peace".
The US decision to abstain infuriated Mr Netanyahu, who has taken diplomatic reprisals against the countries that voted in favour of the resolution.