Stocks jumped at the start of what could be the most important week of the year for Wall Street as hopes grew that European leaders will find a solution to the region's debt crisis at a summit on Friday.
The bloc's crisis has been the biggest overhang for U.S. investors this year. Hope that European policymakers were entering an endgame sent the S&P 500 to its best week in almost three years last week with a rise of 7.4 percent.
Many are betting even a temporary fix in Europe will allow investors to focus on improvement in the U.S. economy and send equities higher into the end of the year. But investors have been let down by European crisis summits before.
Paul Zemsky, head of asset allocation at ING in New York, said he is positioned for a favorable outcome but warns failure to reach an agreement that would allow Europe's central bank to step up purchases of government debt could cripple Europe's bond markets and send stocks into a tailspin.
Investors will lose complete confidence in the bond markets of France on out, he said. There's no feasible Plan B, there's no ceiling on these yields if there isn't policy action -- it's gone too far.
The financial sector, which has been hit hard this year due to concern about its exposure to Europe and global growth, was the best performing. The S&P financial index <.GSPF> rose 2.8 percent. Morgan Stanley
The S&P 500 inched above its 200-day moving average but failed to hold it in a sign the market is now meeting considerable resistance in the way of further gains.
The Dow Jones industrial average <.DJI> gained 149.78 points, or 1.25 percent, to 12,169.20. The Standard & Poor's 500 Index <.SPX> rose 20.86 points, or 1.68 percent, to 1,265.14. The Nasdaq Composite Index <.IXIC> added 43.73 points, or 1.66 percent, to 2,670.66.
French President Nicolas Sarkozy and German Chancellor Angela Merkel met in Paris, and Sarkozy said a proposed agreement between the two countries will be sent to EU officials on Wednesday ahead of Friday's summit.
The proposal to be taken up at the EU summit will mean a modified EU treaty, which will need to be approved by all 27 European Union leaders. In addition, a budget-balancing rule across the euro zone will be included.
Investors are hoping the agreement will pave the way for the European Central Bank to buy large amounts of government bonds, an outcome the Germans have been keen to avoid without an end to what they see as profligate government spending.
Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co. in San Francisco said stocks could rally into the end of the year if a convincing deal is reached in Europe, but he cautioned against too much optimism too soon. Markets have rallied into a hoped-for euro zone deal before, only to be let down.
We are far from an easy consensus that it's a done deal, he said. But we are further along in the negotiations than we've been and we are focused on the right things now.
Indexes posted their largest weekly percentage advance last week since mid-March 2009. Those gains also came on a U.S. unemployment rate that dropped to a 2-1/2 year low.
Adding to the belief that Europe would be taking adequate steps to address its issues, Italy unveiled a $40.32 billion package of austerity measures, which eased tensions surrounding the country's finances. European stocks <.FTEU3> rose 1 percent while yields on 10-year Italian government bonds fell to the lowest in a month.
The pace of growth in the vast U.S. services sector slowed more than expected in November, according to the Institute for Supply Management, dropping to the lowest level since January 2010.
Commercial Metals Co
(Editing by Kenneth Barry)