Wall Street found its footing over the past week after the market's drubbing earlier this month, as investors pondered whether the storm over housing and a related credit squeeze was over.
Despite a strong rebound in the week to Friday, analysts said they expect nervous trading ahead with market participants looking for signs of contagion from the US housing and mortgage crisis.
The blue-chip Dow Jones Industrial Average rallied 2.29 percent in the week to Friday to 13,378.87, recouping some of its heavy losses from earlier this month.
The broad-market Standard & Poor's 500 advanced 2.31 percent to 1,479.37 while the tech-dominated Nasdaq composite leapt 2.86 percent to 2,576.69.
Sentiment was helped by what appeared to be a partial thawing in frozen credit markets, easing fears of a money squeeze that could spill over to corporate and consumer borrowing and drag on economic activity.
"While the stock market remains nervous regarding the impact of the current mortgage credit crisis and the meltdown of the commercial paper market, the tension level appears to have relaxed over the last few days," said Frederic Dickson, market strategist at DA Davidson.
"The good news is that while the credit markets have undergone significant strain, it apparently hasn't dampened the enthusiasm of global investors for equities in a wide variety of global markets. Several have rallied to new record highs as the US stock market still lingers below record highs set in mid-July," he said.
"Chalk up some of the improvement in financial conditions to further central bank efforts this week to add reserves to the banking system, strengthen the liquidity of credit markets and shore up investor confidence," said Derek Burleton, analyst at TD Bank Financial Group.
"Yet despite this reassuring news, clear signs of distress in the market remain. For one, the commercial paper market (for short-term corporate loans) remains in a state of paralysis."
Analysts say that credit -- one key to economic activity -- will remain tight and more expensive until market participants sort out what has happened to the "junk" mortgages from subprime loans that have been packaged into many portfolios. These have turned up in Asian and European banks as well as hedge funds and other investments.
"The subprime mortgage meltdown has triggered a broad sell-off across capital markets, with incipient elements of financial contagion and panic," said Paul Sheard at Lehman Brothers.
"Questions remain. Do these shocks presage a serious and prolonged downturn in the US economy that will spill over to the rest of the global economy, perhaps as part of a multiyear adjustment of global imbalances?"
Sheard said he sees the expansion continuing globally "but the risks of the gloomier outcome have risen."
Some calm has been restored by central bank actions. The US Federal Reserve cut its discount rate August 17 by a half-point, aiming to eliminate the stigma of direct loans from the central banks. The Fed and European Central Bank have been pumping more liquidity into markets as well.
"The Fed's actions ... rate have helped calm the anxiety in financial markets," said Sal Guatieri, an analyst at BMO Capital Markets.
"US stocks have recovered about half their peak-to-trough losses (which amounted to 12 percent at one point)."
Most investors are expecting the Federal Reserve to cut its base federal funds interest rate next month as part of the move to keep credit flowing in the economy. But some say the Fed faces a dilemma because a cut could signal further economic headwinds.
"Market optimism is back. But if it's based mainly on expectations for a Fed rate cut, then the recent stock market recovery is on shaky ground," said Benjamin Tal at CIBC World Markets.
"Even if (Fed chairman Ben) Bernanke ends up cutting, it would be an admission that the situation is really bad, with negative macroeconomic implications -- hardly a positive scenario for equities."
Bonds remained well-bid as some investors opted to hold safe-haven investments like Treasuries during the market turmoil.
The yield on the 10-year US Treasury bond eased to 4.633 percent from 4.673 percent a week earlier. The 30-year bond yield eased to 4.897 percent from 5.000 percent. The drop in yields reflected a rise in prices.
