Stocks surged Friday, with the Dow and the S&P 500 both reaching 3 1/2-year highs, after a better-than-expected jobs report increased optimism about the economy but didn't raise worries about accelerated interest-rate hikes by the Federal Reserve.

The Dow Jones industrial average (search) gained 107.52 points, or 0.99 percent, to end at 10,940.55. The Standard & Poor's 500 Index (search) rose 11.65 points, or 0.96 percent, to finish at 1,222.12. The Nasdaq Composite Index (search) rose 12.21 points, or 0.59 percent, to close at 2,070.61.

The Dow closed at its highest level since June 2001, putting it back in sight of the psychologically important 11,000 mark, while the S&P 500 closed at its highest since July 2001. Only three of the 30 Dow stocks closed lower.

For the week, the Dow was up 0.90 percent, the S&P 500 rose 0.91 percent, and the Nasdaq was up 0.34 percent.

"The catalyst for the rally today is the payroll report," said Brian Pears, head of equity trading at Victory Capital Management. "I think that most traders thought the economy was in relatively good shape, but this gives us an inkling that the economy is even stronger than we thought."

According to the Labor Department (search), 262,000 jobs were created in February, far more than the 225,000 economists expected and the most in four months. Jobs were created throughout the economy, from retail to manufacturing.

Investors fearing inflation — especially with the increased consumer demand that comes with job creation — were assuaged somewhat by other aspects of the report. The nation's unemployment rate ticked up to 5.4 percent, from 5.2 percent last month. And hourly earnings were surprisingly flat, which means workers' paychecks aren't growing and that businesses may have a hard time raising prices.

"It hit the sweet spot," said Jack Caffrey, equities strategist at J.P. Morgan Private Bank. "You got more people getting jobs, that's the important thing, and you have growth in wages, but not enough to raise fears of inflation. And that's really helping the market right now."

Interest-rate sensitive stocks such as financials gained as fears were eased about aggressive rate increases. Citigroup Inc. (C) was up nearly 1 percent, or 43 cents, at $48.40, and JP Morgan Chase and Co. (JPM) was up 1.4 percent, or 50 cents, at $37.51.

High interest rates weigh on stocks as they increase the cost of borrowing for companies, and are particularly bad for financial services companies because they slow the lending volume while raising the cost of acquiring funds.

In another positive, U.S. factory orders unexpectedly rose 0.2 percent in January, a government report showed.

Energy stocks gained as the price of crude stayed lofty. Exxon Mobil Corp. (XOM) rose 0.8 percent, or 52 cents, to $63.57 and ConocoPhillips (COP) gained 1.5 percent, or $1.61, to $112.21.

Oil for April delivery settled 21 cents higher at $53.78 a barrel after rising to near-record highs over $55 Thursday.

Shares of U.S steel makers advanced as another major international manufacturer said it would increase prices because of higher raw material costs. Nucor Corp. (NUE) jumped 5.3 percent, or $3.23, to $63.83, AK Steel (AKS) climbed 4.2 percent, or 70 cents, to $17.20 and U.S. Steel (X) gained 3 percent, or $1.80, to $61.45.

Dell Inc. (DELL) rose 2.2 percent, or 87 cents, to $40.87 after the personal computer maker announced a $10 billion share buyback. Apple Computer Inc. (AAPL) went up 2.4 percent, or $1.02, to $42.81 after Prudential Equity Group raised its stock price target and revenue and earnings estimates for Apple.

Johnson & Johnson (JNJ) added 99 cents to $67.74 — reaching a new 52-week high — after it said it will acquire Closure Medical Corp., a maker of medical adhesives, for $370 million. Closure climbed $4.28 to $26.68 on the news.

Embattled electronic data manager ChoicePoint Inc. (CPS) announced that the Securities and Exchange Commission is investigating stocks sales by its top executives. The company is also dealing with the aftershocks surrounding a severe computer security breach that exposed thousands of customers' private information to malicious computer hackers. ChoicePoint skidded $2.63 to $37.65.

Martha Stewart Living Omnimedia Inc. (MSO) slid $3.20 to $30.75 as founder Martha Stewart returned to her Bedford, N.Y., home after five months of incarceration for obstruction of justice. She still must serve five months of home confinement, but can resume working.

High-end department store company Saks Inc. (SKS) saw an 18 percent jump in fourth-quarter profits and earning 67 cents per share, in line with Wall Street expectations. Saks nonetheless fell 58 cents to $15.02.

Shares of Biogen were down 4.2 percent to $37.65 while Elan tumbled 14 percent to $5.72 on the Inet electronic brokerage. Both stocks plunged earlier this week when the companies suspended sales of Tysabri after one patient died of progressive multifocal leukoencephalopathy.

Trading was active, with 1.64 billion shares changing hands on the New York Stock Exchange, above the 1.46 billion daily average for last year. About 1.83 billion shares were traded on Nasdaq, just above the 1.81 billion daily average last year.

Advancers outnumbered decliners on the New York Stock Exchange by about 13 to 4 and by about 3 to 2 on Nasdaq.

The Russell 2000 index of smaller companies was up 6.66, or 1 percent, at 644.95.

Overseas, Japan's Nikkei stock average rose 0.14 percent. In Europe, Britain's FTSE 100 closed up 0.43 percent, France's CAC-40 gained 0.74 percent for the session, and Germany's DAX index climbed 1.15 percent.

Reuters and the Associated Press contributed to this report.