Stocks rebounded sharply on Tuesday as investors latched onto signs of easing stress in Europe's bond markets as well as some positive economic data at home and abroad.

U.S. housing starts and permits for future construction surged to a 1-1/2 year high in November as demand for rental apartments rose. The news reinforced the view that that U.S. economy will continue to see moderate growth.

The Dow Jones home construction index <.DJUSHB> jumped 5 percent led by Pultegroup
, the second largest U.S. homebuilder, up 8.5 percent to $6.07, and MDC Holding , up 6.5 percent to $17.22.

We have been expecting a rally for a couple of days now and finally we got it today, said King Lip, chief investment officer at Baker Avenue Asset Management in San Francisco.

I think it will continue into the end of the year, the reason being that the economic data is clearly much better than everyone's expecting.

Major indexes were well over 2 percent higher in moderate trading volume, narrowing the S&P 500's losses for the year to a little under 2 percent. Some of the strongest gains came in cyclical areas of the market, such as financials and commodity-related stocks.

The S&P's financial index <.GSPF>, which fell sharply in the last session, gained 3.2 percent. Bank of America jumped 3 percent to $5.14 after falling below $5 for the first time in nearly three years on Monday.

In Europe, the Munich-based Ifo think-tank said German business sentiment rose sharply in December, defying expectations it would decline and underscoring the resilience of Europe's biggest economy.

Short-term financing costs for struggling Spain more than halved as banks lapped up debt at an auction. The fire power is apparently coming from the European Central Bank's first ever three-year funding tender on Wednesday. Investors hope banks will use the cheap funding to buy debt of fiscally troubled EU nations.

Investors have been focused on how the large southern European economies will refinance debt next year if financing costs remain excessively high. Any sign yields may be easing is seen as a positive for markets.

The Dow Jones industrial average <.DJI> gained 271.93 points, or 2.31 percent, to 12,038.19. The Standard & Poor's 500 Index <.SPX> rose 29.50 points, or 2.45 percent, to 1,234.85. The Nasdaq Composite Index <.IXIC> added 71.06 points, or 2.82 percent, to 2,594.20.

It's not just a question of a bounce back off of what happened yesterday, which is part of it, but you are also seeing to a large degree some fear alleviated particularly because of the appetite for Spanish debt that was showcased in the overnight, said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey.

The U.S. is the relative darling for world markets and we get an inordinate amount of attention on the upside, when things in Europe stabilize, even if it's only momentarily.

Headlines and fluctuating European bond prices continue to spark high volatility. Stocks will be prone to large swings this week on expected low volume due to the upcoming Christmas Day and New Year's Day holidays.

The S&P 500 has gained an average of 1.6 percent in the last five days of the year and the first two days in January since 1969, according to the Stock Traders Almanac.

The phenomenon is called the Santa Claus rally. Occasions when the market does not rally during those dates often precede a bear market, the Almanac says.

The S&P fell more than 1 percent on Monday, coming close to a key technical support level at the 1,200 level.

Networking stocks rose after AT&T Inc dropped its bid for T-Mobile USA, the Deutsche Telekom unit, as investors anticipate spending on wireless equipment would accelerate.

U.S.-listed shares of Alcatel-Lucent surged 13.7 percent to $1.58 and Juniper Networks Inc climbed nearly 10 percent to $19.78. The NYSEArca Networking index <.NWX> jumped 5.5 percent. AT&T shares edged up 1 percent to $29.03.

(Reporting By Edward Krudy; Editing by Kenneth Barry)