U.S. stocks surged on Thursday, with the Dow Jones Industrial Average marking its best session this year, as Wall Street embraced a drop in applications for jobless benefits as indicative of an improving U.S. labor market and economy, a day ahead of the monthly jobs report.
"It's the absence of bad news," Kate Warne, investment strategist at Edward Jones, said of Thursday's rally.
"What we've seen over the last week or so is the market looking for direction, and then we had worries about emerging markets and slowing U.S. growth, so the knee-jerk reaction was to sell and ask questions later. Now there are indications that the job number may not be as bad as people were fearing so emotions are calming down," she added.
"If you look at U.S. markets in the last week or two, it's really not justifiable based on U.S. fundamentals. Claims coming down is part of that story, it suggests again that maybe the economic story is just fine in the U.S.; we'll find out tomorrow," said David Kelly, chief market strategist, J.P. Morgan Funds, referring to 2014 declines that have the S&P 500 on track for a fourth weekly loss.
Technical levels seemingly played into Thursday's rally as well. The fact that the S&P 500 on Wednesday closed above 1,750, "that was an important level to hold for bulls, and gave us some momentum going into today," said JJ Kinahan, chief strategist at TD Ameritrade.
"The market was heavily oversold. you tried for two days to have a credible rebound and this is the first one you've seen. This is a combination of short covering and the buy the dippers," said Art Cashin, director of floor operations at UBS.
(Read more: Cashin on Why the market rebounded Thursday)
Talk from European Central Bank President Mario Draghi helped push up the euro, with one trader saying the 'risk on' trade started after Draghi's comments boosted the currency, which jumped after Draghi said there was no deflation problem.
"The risk on trade is going on a little bit here. Our market is ripping higher. It's an oversold bounce for sure. You look at the 10-year and it's not dislocating to the downside that much. It's a little weaker….I'd be more willing to trade this rally if the 10-year was at 2.75," said one trader. "You're adding on the dip ahead of a very big number."
The Dow Jones Industrial Average rallied 188.30 points, or 1.2 percent, to 15,628.53.
The S&P 500 rose 21.79 points, or 1.3 percent, to 1,773.43, with consumer discretionary leading a broad-based that extended to all but one - telecommunications - of its sectors.
General Motors edged lower after the auto manufacturer reported a fourth-quarter profit below expectations. Walt Disney rose after tallying quarterly profit above estimates. Twitter fell sharply following its first earnings report as a public company.Coca-Cola climbed after it said it would pay about $1.25 billion to buy a 10 percent stake in Green Mountain Coffee Roasters. Green Mountain jumped 26 percent.
(Read more: Green Mountain roasts Einhorn's Greenlight)
The Nasdaq surged 45.57 points, or 1.2 percent, to 4,057.12.
For every share falling, more than three gained on the New York Stock Exchange, where 743 million shares traded. Composite volume topped 3.8 billion.
The dollar declined against the currencies of major U.S. trading partners; the yield on the 10-year Treasury note used in determining mortgage rates and other consumer loans climbed 3 basis points to 2.703 percent.
Economic reports Thursday had unemployment claims falling by 20,000 to 331,000 last week, with the weekly data coming in ahead of Friday's nonfarm payrolls report for January.
"This really is like a two-month employment report because last month's was so outrageous," said Ameritrade's Kinahan of the December data, which had payrolls up a measly 74,000, with the number largely disregarded because it was so far off anyone's radar. Wall Street is looking for s significant revision to the December number in Friday's report, Kinahan said.
"As the week has progress, the feeling of fear has mitigated," said Kinahan, pointed to the sharp decline in the CBOE Volatility index, or VIX, widely viewed as a measure of investor uncertainty.
Other economic data Thursday had the U.S. trade deficit expanding 12 percent to $38.7 billion. The Commerce Department report illustrated a broad-based drop after jumping in November, as imports edged higher on increasing consumer demand.
Another report had fourth-quarter productivity coming in a 3.2 percent, versus expectations it would fall to 2.5 percent from 3.0 percent.
Overseas, the ECB kept its rates unchanged at a record low, as expected, and Draghi told a news conference that risks to the euro zone were still on the downside, but that turmoil in emerging markets could hinder economic recovery.
On Wednesday, U.S. stocks fell mildly after a better-than-expected report on the service sector helped neutralize another that had companies adding slightly fewer employees to their payrolls than anticipated in January.
—By CNBC's Kate Gibson