By Anna Hirtenstein and Gunjan Banerji

Investors dumped government bonds and piled into shares of economically sensitive companies on Friday, betting that the U.S. economy will rev up in coming months.

The Russell 2000 index of small companies gained more than 2%.

Gains in other major indexes were more muted. The Dow Jones Industrial Average and Nasdaq Composite pared their earlier gains to finish little-changed. The Dow added less than a point, while the Nasdaq rose nearly 0.1%. The S&P 500 slipped 0.2%.

In bond markets, the yield on the 10-year Treasury note rose to 1.348%, from 1.286% on Thursday.

The jump comes as the economy seems to improving, stoking enthusiasm about a speedy recovery.

New data on Friday showed that business activity in the U.S. private sector held up, boosted by accelerating service activity and manufacturing output. That followed a report Wednesday that showed consumers used stimulus checks to boost retail spending in January to the largest increase in seven months. Some economists have increased estimates of gross domestic product for the first quarter of the year.

JPMorgan Chase strategists said Friday that they expect consumers to shatter expectations for the rest of the year given expected fiscal stimulus and economic reopening as the pandemic eases. Meanwhile, Federal Reserve Bank of Boston President Eric Rosengren said he expects the economy to pick up steam this year as vaccines are distributed.

This optimistic outlook led investors to ditch Treasurys and pile into economically sensitive stocks in the financials and energy sectors, helping those groups outperform their peers and notch big weekly gains.

But the climb in bond yields this week has also prompted some investors to question whether risky assets such as stocks are looking less attractive, said Kiran Ganesh, a multiasset strategist at UBS Global Wealth Management.

"A main driver for equity markets over the past few months has been a lack of competition," Mr. Ganesh said. "If yields rise, then we could see some people rotating away from growth names and toward credit or bonds."

Stocks have come under pressure in recent days as high valuations for technology stocks and rising bond yields weighed on sentiment. The Dow posted a modest gain for the week, while the S&P 500 and Nasdaq Composite ended the week lower.

"Investors are taking a little bit of a pause," said Arthur van Slooten, global asset allocation strategist at Société Générale. "We believe there is further to go. When the reflation trade is back on and there is more confidence about this, we'll see a continuation of the market performance that we've had" in recent weeks, he added.

In corporate news, agricultural equipment maker Deere jumped about 11% after saying it expects solid profit growth in 2021, making it one of the best performers in the S&P 500 on Friday.

Cruise operators, airlines and financials companies were among other top performers. Shares of Carnival added around 6.9%, while American Airlines gained about 5.7%.

People have also piled into bitcoin, sending its market cap above $1 trillion for the first time, according to Dow Jones Market Data.

Oil prices pulled back after U.S. diplomats said late Thursday that they may meet with Iran officials for nuclear talks in the coming weeks, prompting speculation that a deal could allow Iran to begin exporting more crude. Brent crude declined 1.6% to $62.91 a barrel.

Investors are closely watching "how quickly Iran could re-enter the market," said Bjarne Schieldrop, chief commodities analyst at Nordic bank SEB. The country is expected to add between 2 million and 3 million barrels a day to global production if sanctions are lifted, he said.

Overseas, the pan-continental Stoxx Europe 600 climbed 0.5%, finishing its third consecutive week of gains. In Asia, major stock benchmarks were mixed. The Shanghai Composite Index closed up 0.6%, while Japan's Nikkei 225 retreated 0.7%.

Write to Anna Hirtenstein at anna.hirtenstein@wsj.com and Gunjan Banerji at Gunjan.Banerji@wsj.com

(END) Dow Jones Newswires

02-19-21 1647ET