This year, the "Magnificent Seven" of U.S. stocks continue their strong rally, supporting the trend of the broader U.S. stock market, becoming the most discussed topic. However, the broader market, overshadowed by the "Magnificent Seven," is quietly undergoing changes in February.

On February 26, Goldman Sachs analysts Kamakshya Trivedi and Dominic Wilson pointed out in a report that, although tech giants are the market focus, the view that the entire market rally is solely driven by them is somewhat exaggerated. In fact, looking at the global trends over the past month, Chinese stock indices (A-shares, CSI 300, Hong Kong's Hang Seng Index, and Hang Seng China Enterprises Index) and European stock indices (Germany, France) have all outperformed the S&P and Nasdaq, while the Russell 2000 and small-cap indices have also outperformed the S&P and Nasdaq, which represent the larger market.

Goldman Sachs candidly states that the current macroeconomic environment still favors risk assets, with the market rally's breadth set to further expand, not limited to a few large U.S. tech stocks. Two major factors are undergoing changes that could create tailwinds for cyclical stocks, non-U.S. currencies, and non-U.S. stock markets: 1. The inflation downtrend remains unchanged, with U.S. short-term interest rates beginning to decline; 2. A rebound in global manufacturing sentiment.

Goldman Sachs explains that current portfolios are still based on robust U.S. economic fundamentals and global inflation slowing. Against the backdrop of a resilient economy and a strong labor market, January's CPI and PPI data both exceeded expectations, making the market overly pessimistic about rate cuts in the short term. However, they judge that the inflation downtrend will remain unchanged, ultimately leading to a decrease in U.S. short-term interest rates.

For the stock market, Goldman Sachs emphasizes that what's more important is the Federal Reserve's willingness and ability to start an easing cycle in the event of slowing economic growth, rather than the number of rate cuts needed to achieve the inflation target.

Meanwhile, since the beginning of the year, the global manufacturing sector has shown signs of gradual recovery, positively impacting global economic growth expectations. The combined effect of the above factors is expected to bring more significant tailwinds to non-U.S. stock markets, non-U.S. currencies, and U.S. small-cap stocks.

The Federal Reserve's rate cut trend remains unchanged

January's CPI and PPI data rebounded across the board, exceeding expectations, while GDP data showed the U.S. economy still has resilience. Investors re-priced rate cut expectations, dumping short-term bonds, causing yields on U.S. Treasury bonds with maturities of 2-5 years to rise rapidly.

Looking at the past three months, the annual growth rate of core consumer prices in the US, excluding food and energy, has rebounded to 4%, higher than the annualized growth rate of 2.6% up to August. However, Goldman Sachs believes that the downward trend in inflation remains unchanged, and with the support of positive macroeconomic fundamentals, stocks are more likely to continue to rise:

Although we believe inflation will continue to decline, whether February's inflation data will show this trend remains uncertain, which may stimulate the market to further lower expectations for the Federal Reserve's rate cuts in the short term.

The market's pricing of the Federal Reserve's future policy is already quite conservative, at a three-month low. Therefore, if future inflation exceeds expectations, the market has little room to adjust. And if inflation slows while the economy remains resilient, leading the market to further reduce bets on the magnitude of the Fed's rate cuts, it would further benefit the stock market.

US stock valuations are at relatively high levels which might pressure the short-term trajectory of US stocks, but overall, under the push of positive economic macro fundamentals, US stocks are more likely to continue to rise.

Goldman Sachs believes that for the stock market, the willingness of the Federal Reserve to start an easing cycle is more important than the number of rate cuts needed to achieve inflation targets.

The breadth of the global market rally is set to expand further. While tech giants are the global market focus, Goldman Sachs believes the view that the entire market rally is solely driven by them is somewhat exaggerated. The breadth of the global market should not be overlooked, and positive macro fundamentals can support higher stock market valuations. The breadth of the global market rally is expected to expand further:

The view that the current US stock rally is "too narrow" is seen as a weakness, but the strong performance of large US tech stocks since the beginning of the year, also due to their strong profitability, should not be overlooked.

In fact, not only the US market but also Japan, Europe (even without the push of AI and technology), and US cyclical stocks (relative to defensive stocks) have performed well. Recently, stock markets in Europe, Japan, and China have outperformed the S&P 500 and Nasdaq indices in their local currencies or in US dollars, showing that the market rally has a broader base, and not just limited to a few large US tech stocks.

Goldman Sachs expects that the breadth of the market rally will further expand leveraging the advantage of macro fundamentals. With the gradual recovery of the non-US economy and global manufacturing growth, not just tech stocks, but non-US stock markets and US small-cap stocks will benefit.

The global manufacturing sector shows signs of recovery. In January, the global manufacturing PMI rebounded to 50, marking the first time in 17 months it has returned to the expansion-contraction threshold. The US Markit manufacturing PMI rebounded to 50.7 (ISM rose to 49.1). In January, both global manufacturing new orders and new export orders rose, reaching the highest level since mid-2022. Demand for orders significantly rebounded in January, reaching the highest point since mid-2022, with order volumes exceeding inventory levels.

Goldman Sachs points out that it is clear from the data that the continuous improvement of the global manufacturing sector will become an important factor in determining future market trends. Manufacturing has long been a drag on global economic growth, but compared to most of the past 18 months, there are now more encouraging signals, suggesting that a turning point for the manufacturing sector may have arrived:

Since the beginning of this year, the global manufacturing sector has shown signs of gradual recovery, bringing a positive impact on global economic growth expectations. With financial conditions continuing to support, US consumption remaining resilient, and an ample supply in the global oil and natural gas markets, there is reason to hope for the continuation of the manufacturing recovery trend. Among these, the European economy may be on the path to recovery, which is good news for global economic growth.

Bank of America strategist Michael Hartnett candidly states that with the manufacturing sector beginning a recovery cycle, he advocates for "going long on global producers and short on American consumers":

Undoubtedly, the strong performance of American consumers in the past 12-18 months has become the biggest support for the US economy, while the weak performance of the manufacturing sector has dragged down the economy. However, as shown in the chart below, we are now at a turning point in the trend between consumer spending and manufacturing. It is evident that the trend between non-farm payroll data and ISM is starting to reverse.

Despite the strong spending power shown by American consumers in the recent period, I anticipate that this trend may not continue due to factors such as the reduction of remaining savings, a decrease in the savings rate, an increase in overdue payments, and a slowdown in hiring, all of which could limit consumers' spending capacity.

The rise in the Global Manufacturing Index (PMI) indicates that production activity is increasing, and with order volumes exceeding inventories, it perhaps means that production activity may continue to be active.

Against the backdrop of a global manufacturing recovery, the team led by Mou Yiling at Minsheng Securities believes that the upstream is entering a period of passive destocking, and active restocking is expected, with inventory cycle positions holding more advantage in the supply chain. The rigidity of the supply side for commodities is being further validated:

Industrial metal inventories are also at historically low levels, with metals represented by copper experiencing a precipitous drop in smelting and processing fees, signaling clear potential supply disruptions. With physical demand becoming the main driver of economic recovery, supply constraints on the resource side will form the strongest resonance with it.