By Aaron Kuriloff 

The Dow Jones Industrial Average shook off its worst-ever start to a year and is now on track for its best performance since 2013, as investors bank on an improving economy.

The index of 30 blue-chip stocks is up around 13% in 2016 even as it fell 0.5% Friday to 19730 on the final trading day of the year. The S&P 500 is up 9.3% this year, and the Nasdaq Composite is up 7.3% for their biggest gains since 2014.

This year's rally extends a bull market that has tripled the Dow industrials from their low during the financial crisis of 6547.05 in March 2009. Stocks weathered several shocks in 2016, including a recession scare, Brexit and the U.S. presidential election of Donald Trump.

The bulk of 2016's gains came in the second half of the year. A rebound in corporate earnings, accelerating U.S. economic growth and stabilizing oil prices helped stoke investor enthusiasm for stocks. The rally gathered pace after the election of Mr. Trump on Nov. 8, as investors bet the new administration would usher in business-friendly policies like tax cuts, looser regulation and fiscal stimulus. The Dow industrials closed above 19000 for the first time ever on Nov. 22 and have gained nearly 8% since Election Day, setting several new closing highs.

However, a stall in the recent rally has raised questions about whether stocks will continue to surge into 2017 and propel the Dow Jones Industrial Average to 20000, its next thousand-point milestone. The Dow industrials were on track Friday for their first weekly loss since the election. Mr. Trump's policies could fall short of expectations, and the rally has made stocks even more expensive by historical measures.

"Now comes the hard part," said Lew Piantedosi, portfolio manager at Eaton Vance. "What are these policies actually going to look like? That's where the true uncertainty lies."

Still, stocks are finishing 2016 better than they began. The Dow industrials delivered its worst-ever five-day start to a year, falling 6.2%. A slide in China's stock market and the weakening yuan sparked selling around the globe, as investors grew concerned about the effects of a slowdown in the world's second-largest economy, including a possible U.S. recession. The Dow bottomed at 15660.18 on Feb. 11, a two-year low, having fallen more than 10% from the end of 2015. U.S. crude-oil futures also hit their 2016 trough that day, settling at $26.21 a barrel on the New York Mercantile Exchange, their lowest level since 2003.

Oil is now on pace for its biggest annual gain since the financial crisis, propelled by a deal among the Organization of the Petroleum Exporting Countries and other major oil producers to cut output after a global glut had pressured the market for two years. U.S. crude is now at $53.72 a barrel, putting it up 45% in 2016, its best year since 2009. Energy is the best-performing sector out of 11 in the S&P 500 this year, rising 23%.

Fears about the U.S. economy have also abated.

U.S. gross domestic product, the broadest measure of economic output, advanced at a 3.5% inflation- and seasonally adjusted annual rate in the third quarter, according to the Commerce Department. It was the strongest reading in two years and followed three straight quarters of sub-2% growth. The unemployment rate has fallen to 4.6%, and U.S. corporate earnings are growing after several quarters of declines.

The Federal Reserve held off on raising interest rates for most of the year before moving in December for the first time since the end of 2015. Officials also signaled more increases are on the way, reflecting optimism about the U.S. economy.

Expectations for higher interest rates have helped put U.S. government bonds on track for a second consecutive year of price declines. The yield on the benchmark 10-year Treasury note, which moves opposite price, is at 2.446%, according to Tradeweb, up from 2.273% at the end of 2015. It's a marked turnaround from earlier this year, when yields tumbled as investors piled into the bond market on the possibility of a prolonged period of sluggish economic growth, low inflation and ultraloose monetary policy. The 10-year yield fell to 1.366% on July 8, its lowest level on record, after the U.K. voted to leave the European Union.

Strong stock prices and sluggish economic growth were a boon to merger activity as they emboldened companies to strike deals presenting opportunities for cost-cutting and profit growth. There were $3.7 trillion of takeovers announced globally in 2016, according to Dealogic. While that represents a decline of roughly 15% from 2015's record of $4.4 trillion, it still makes 2016 the third-most-active year for mergers.

Brighter economic prospects have boosted the dollar late in the year. The WSJ Dollar Index, which measures the dollar against a basket of 16 other currencies, is up around 3% in 2016. However, a strengthening U.S. currency could threaten the nascent recovery in U.S. corporate earnings by making U.S. exports more expensive to foreign buyers and reducing the value of companies' overseas revenues.

In addition, some investors are skeptical that corporate earnings will grow enough to support stock valuations, which are higher than their historical average. Shares of companies in the S&P 500 traded at an average of roughly 21 times their past 12 months of earnings Thursday, above their 10-year average of 16, according to FactSet.

While investors grew more hopeful for further gains toward the end of the year, several said the rally would stand on firmer ground with additional support from policy and the economy.

"I posit that a lot of assumptions that have been made over the past few months are pure speculation and we have no idea what's going to happen," said Jim Tierney, chief investment officer of concentrated U.S. growth at AllianceBernstein Holding LP. "The first few months of 2017 are going to be more important, as we read the tea leaves, than the past few months."

--Akane Otani contributed to this article.

Write to Aaron Kuriloff at aaron.kuriloff@wsj.com

(END) Dow Jones Newswires

December 30, 2016 15:36 ET (20:36 GMT)