Stocks recovered from early declines after leaders of the Senate and House emerged from a meeting at the White House and indicated they would be flexible in efforts to settle fiscal policy differences.
Democrats said they recognized the need to curb spending and Republicans said they had agreed to put "revenue on the table" following a meeting with President Barack Obama.
For the week, the S&P was down 1.5 percent, its second week in a row of losses. The Dow lost 1.8 percent, down for the fourth straight week, while the Nasdaq was lower for the sixth week, also losing 1.8 percent.
"These are very small steps in the right direction," said Kate Warne, investment strategist at Edward Jones in St Louis.
"The more evidence there is that Congress will make a decision sooner, the more likely we are to see stocks rebound."
About $600 billion of automatic budget cuts and tax increases will start to take effect in the new year unless Washington reaches a deal. With memories of 2011's debt ceiling impasse fresh in investors' minds, many are worried this year's discussions could be drawn out or yield no agreement.
If all the changes go into effect, economists say it could tip the economy into recession. Investors have pulled out of stocks over the past two weeks, taking nearly 4 percent off the S&P 500.
The Dow Jones industrial average <.DJI> added 45.93 points, or 0.37 percent, to 12,588.31. The Standard & Poor's 500 Index <.SPX> rose 6.55 points, or 0.48 percent, to 1,359.88. The Nasdaq Composite Index <.IXIC> gained 16.19 points, or 0.57 percent, to 2,853.13.
Shares of Penn National Gaming Inc (>> Penn National Gaming, Inc) surged 28.2 percent to $48.23 on its busiest day of trading in more than four years, after the owner of gaming and pari-mutuel properties said late Thursday it will split its business into a gaming-focused real estate investment trust and a gaming operator.
More than 10 million shares changed hands, compared with average daily volume of 629,000 shares over the past 50 days.
Dell Inc (>> Dell Inc.) helped limit the Nasdaq's gains after lower PC sales hurt the company's profit. Dell slumped 7.3 percent to $8.86.
More violence in the Middle East also kept investors wary after Palestinian militants nearly hit Jerusalem with a rocket for the first time in decades and fired at Tel Aviv for a second day.
Sears Holdings Corp (>> Sears Holdings Corporation) late Thursday reported a quarterly loss that was narrower than expected, but same-store sales fell on weak demand for electronics, sending shares down 18.8 percent to $47.49.
Volume is expected to be light next week with some investors away for the Thanksgiving holiday, and the market closed on Thursday and open for only a half-day on Friday.
The decreased liquidity could spell more intra-day volatility for the market, though fewer market participants could also mute action.
Volume on Friday was roughly 7.52 billion shares on the New York Stock Exchange, the Nasdaq and the NYSE MKT, well above the year-to-date average daily closing volume of about 6.52 billion.
Advancers outnumbered decliners on the NYSE by 2,258 to 784 on the New York Stock Exchange. On the Nasdaq, advancers also had the upper hand by 1,446 to 997.
(Editing by Kenneth Barry)
By Leah Schnurr