Manufacturing posts best showing since 2006

That coincided with other data on Monday showing world factory activity expanded last month at its greatest clip in nearly four years.

But headwinds for the U.S. economy remain, as a separate report showed construction spending fell in November to a more than six-year low, depressed by a decline in homebuilding.

The focus, though, was on the Institute for Supply Management's national factory index, which rose to 55.9 in December from 53.6 in November.

That was the highest reading since April 2006, when the index stood at 56.0. A result above 50 indicates expansion.

Stocks rallied, led by commodity and financial shares, as the ISM data pointed to a steady economic recovery. Major indexes closed up more than 1 percent, with the Nasdaq marking its highest close in 16 months.

This is what we need in 2010 for a V-shaped recovery, said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio.

After tumbling in late 2007 into its worst recession since the 1930s, the U.S. economy returned to growth in the third quarter of 2009, expanding at 2.2 percent annual rate.

While the economy still shed jobs through November, the pace of overall losses slowed. Economists polled by Reuters expect data later this week to show employers slashed 8,000 jobs last month after losing 11,000 in November.

In early 2009, the economy was losing around half a million jobs per month, according to government data.

The ISM data hinted at continued improvement on this front, with its closely-watched employment index edging up to 52.0 from 50.8 and new orders rising to 65.6 from 60.3.

Manufacturing will continue to be an area that provides support to the U.S. economy, said Kevin Flanagan, fixed-income strategist for global wealth management at Morgan Stanley. We are looking to see if we can build on this recovery.

CONSTRUCTION SPENDING STILL WEAK

How much steam the economy builds in the coming months should help determine when the Federal Reserve raises borrowing costs from current record lows near zero, analysts said.

While the Fed said it plans to wind down most emergency lending by February, it has not deviated from a stated intention to hold rates low for an extended period, which markets have interpreted to mean unchanged rates until at least the second half of 2010.

Torsten Slok, senior economist at Deutsche Bank in New York, said the strong manufacturing data has to change the Fed-speak and Fed body language going forward.

But in a separate report, the U.S. Commerce Department said construction spending fell 0.6 percent in November. The decline to $900.1 billion, the lowest level since July 2003, was the seventh straight month of weakness in the industry.

Spending on private home building dropped 1.6 percent, the biggest decline since June, after rising 4.8 percent the prior month.

There was reason to be cautious about the manufacturing sector outlook as well despite Monday's data.

Cliff Waldman, an economist for the Manufacturers Alliance/MAPI, said high unemployment will keep consumers anxious and keep household and business demand subdued even as a global recovery takes hold.

These issues suggest that while 2010 will be a recovery year for the U.S. factory sector, it will likely be muted and insufficient to soak up historic excess capacity, he said.

(Additional reporting by Emily Flitter, John Parry, Ryan Vlastelica and Lucia Mutikani; Editing by Kenneth Barry)