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Markets Rally on Jobs Report, But Is Worst Really Over?

Friday's market rally featured the latest round in the battle of whether a gradually improving US economy can outweigh Europe fears, with the home team winning—at least for the moment.

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With the real Super Bowlset in Indianapolis for Sunday, Wall Street’s own big game centers on whether increases in employment, auto sales and other areas outweigh the pressures that European debt defaults could have on the global economy.

For the moment, even market bears are willing to cede at least a little ground, if only for now.

"It’s a bit of an improvement," says Walter Zimmerman, senior technical analyst at United-ICAP in Jersey City, N.J. "It’s better than it was, but we’re skeptical that it’s sustainable given the continuing unraveling."

Last week, Zimmerman had set 1325 as a resistance level for the Standard & Poor’s 500 . The index since has eclipsed that mark, and its more narrowly based peer, the Dow industrials, also is threatening to break a three-and-a-half year post-financial crisis high.

The market’s primary struggle over the past nine months or so has been to shake off the troubles in Europe, where Greece is nearing a likely debt default next month and its neighbors face similar travails ahead.

Zimmerman thinks investor sentiment has become overdone and will be shown imprudent once the sovereign debt crisis begins to recapture the daily headlines.

"We think the next big bomb to drop will be coming from Europe anyway," Zimmerman said in response to the jobs report that showed the unemployment ratefalling to 8.3 percent and payrolls expanding by 243,000. "The (Organization for Economic Development) leading economic indicator is well on its way to slipping back into recession, so we think that’s going to be a big drag on the U.S. economy."

Economists also remained skeptical that the job-growth trend would stay intact.

"We’ve been here before with 200,000 plus monthly gains in payrolls in spring 2010 and spring 2011 that ultimately came to nothing," Toronto-based Capital Economics said in a note to clients. "With housing still in the dumps, fiscal policy being tightened and the euro-zone crisis likely to flare up again at any moment, we still think the US will endure another year of weak growth in output and employment."

Investors, though, are behaving as if they haven’t got a care, pushing the S&P 500 up year-to-date 5.4 percent as of Thursday's close, and another 1.3 percent by around mid-day Friday.

"The big question is, will this translate to higher equity prices? We think it will, as with more jobs should come an improvement in confidence," says Ryan Detrick, senior analyst at Schaeffer’s Investment Research in Cincinnati. "We all know how dour things looked just a few months ago, and now with some good news maybe the massive amounts of inflows to bonds and money markets we've seen the past few years will finally work its way into stocks."

That’s despite some fairly stern warnings from policy makers — the Federal Reserve , in particular — that the outlook for employment specifically and the economy in general remains shaky.

"The Fed needs to get away from this crisis mindset," says James Paulsen, chief market strategist at Wells Capital Management in Minneapolis. "You don’t have to approach this like we are still in an emergency. Zero-interest rates is not normal accommodative policy. In some ways this Fed is suffering from post-traumatic stress disorder. They can’t seem to get away from this mindset."

The jobs growth at least should take a third round of asset purchases — known as quantitative easing — off the table, says Paulsen, who believes investors soon will begin worrying more about inflation than the deflation the central bank has been fighting.

Given a market without Fed influence, he think investors more comfortable in their own jobs will put money to work on their own.

"The real thing in this is what it does for confidence for those that are already employed," Paulsen says. "Confidence-building gives us a chance to get to new high territory. We’re planting the seeds already."

Jobs Friday, though, has typically been a bad day for the market, despite the streak of positive job gains. The S&P 500 has finished negative the past eight first-Fridays when the government reports the numbers, a streak that could be broken today.

That would be in line with strongly bullish sentimentthat has dominated trading since the calendar turned the page to 2012. Fund flows have shown improvements for the past few weeks, and investor sentiment surveys remain strongly bullish.

With Europe continuing to lurk in the background, the market could be setting up for a retreat, a sentiment echoed even by those who think Wall Street is on its way to a positive year.

"We’re starting to see some investors buy into the economic expansion," says Brad Sorensen, director of market and sector analysis at Charles Schwab in San Francisco. "Investor sentiment for the short term has gotten a little bit extended. February has not traditionally been a great month for the stock market. We wouldn’t be surprised to see a little bit of a pullback."