Winter 2025

2024 was another good year for US equity investors, with financial markets delivering attractive returns across the board. The numbers tell a compelling story: the tech-powered S&P 500 soared 25.02%, while the Russell 2000 (R2) small-cap index posted a solid 11.54% gain. Behind these impressive returns lies a tale of economic resilience that few saw coming.

The US economy far exceeded the forecasts of most economists for 2024, many of whom began the year forecasting a recession. In fact, Gross Domestic Product (GDP) grew steadily throughout the year, averaging about 2.75% (GDPNow Atlantic Fed estimate).

                        Real GDP by Quarter, Percent Change from Preceding Period

Source: U.S. Bureau of Economic Analysis via https://fred.stlouisfed.org/series/A191RL1Q225 SBEA#0

The expanding economy created many new jobs, averaging about 186,000 per month (US Bureau of Labor Statistics), and unemployment remained subdued.

                                             Unemployment Rate, by Month

Note: Seasonally adjusted                                                                                                                Source: U.S. Bureau of Economic Analysis via https://fred.stlouisfed.org/series/A191RL1Q225S  BEA#0

Perhaps most important, inflation continued a steady retreat from its post-pandemic peak of nearly 9%, down to about 3%.

                                                        Consumer Price Index

Note: Shaded area represents recession, as determined by the National Bureau of Economic Research

Source: U.S. Bureau of Labor Statistics (https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm)

This confluence of positive data gave the Federal Reserve (Fed) cause to pivot from its hawkish stance to a more accommodative monetary policy. The Fed delivered what markets had long awaited: a reduction in the Fed Funds rate, starting with a 50-basis-point reduction in September, followed by two 25-basis-point cuts in October and December. The positive data on the economy combined with declining interest rates to provide fuel for the rally in US equity markets.

                                               Federal Funds Rate, by Month

Note: Federal Funds Effective Rate, not seasonally adjusted

Source: Board of Governors of the Federal Reserve System(US)via https://fred.stlouis.org/series /FEDFUNDS

While 2024 was unquestionably a successful year for US investors, a few concerns began to emerge in the fourth quarter. Inflation as measured by the Consumer Price Index (CPI) bottomed out towards the end of the summer and ticked up modestly in the fall. The increase, although small, along with continued strong GDP growth prompted the Fed to pause further rate reductions. This shift in FED policy reverberated through the fixed-income markets, pushing the 10-year Treasury yield up 100 basis points to approximately 4.5%. The equity markets quickly reminded investors of their interest-rate sensitivity, with the S&P 500 declining 2.38% and the Russell 2000 tumbling 8.26% in December.

The fourth quarter’s market dynamics were heavily influenced by shifting Federal Reserve policies and their impact on interest rates. Early in the quarter, moderating inflation data and the Fed’s rate cuts drove strong market gains. However, this momentum reversed in December as concerns for the incoming administration’s policies coupled with stubborn inflation led to a rise in longer-term interest rates and a sell-off in equity markets.

Looking ahead to 2025, economists are generally forecasting a continuation of the current favorable trends in GDP growth, inflation and interest rates. In addition, there are several emerging themes that could favorably impact the economy. The reshoring of manufacturing operations to the US will benefit many industrial companies. Additionally, the adoption of Artificial Intelligence (AI) technologies will create opportunities for both technology providers and businesses leveraging these tools to improve operations. The combined impact could meaningfully increase productivity that could support economic growth for years to come. Still, we caution investors to view such forecasts with a healthy dose of skepticism and to expect continued market volatility, particularly as the new administration’s policies take shape.

The S&P 500’s current valuation of 22x forward earnings is near the high end of the historical range. But this is largely due to a handful of dominant tech giants whose businesses have thrived in the post-pandemic economic expansion. Meanwhile, a broader market index, represented by the Russell 2000, trades near its 15-year average of 18x forward earnings. Additionally, analysts are forecasting healthy growth in corporate profits in 2025. Earnings for the S&P 500 are expected to grow 15%, with a projected increase of 36% for the Russell 2000 companies.

Despite the volatility anticipated in 2025, we believe this environment plays to our strengths at Ironwood. Market volatility may create near-term uncertainty, but it also presents opportunities to invest in strong businesses at attractive prices, which has long been a core component of our investment philosophy. Our disciplined investment approach focuses on identifying companies with strong competitive positions, healthy balance sheets, and sustainable business models, companies we refer to as High IQ investments (High “Ironwood Quality”). This strategy has proven effective through various market cycles, as evidenced by our performance for over 25 years since our founding in 1997.

Sincerely,