First Quarter Investment Commentary Reality is merely an illusion, albeit a very persistent one. Albert Einstein

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1 First Quarter Investment Commentary 2016 Reality is merely an illusion, albeit a very persistent one. Albert Einstein U.S. equity markets, in a word, were volatile in During the first half of the year the stock market rode the lingering tailwinds of Quantitative Easing to a jerky yet positive conclusion. Following a significant selloff in August and September, the S&P 500 staged an 8% rally during the fourth quarter. All this leaving the major Index nearly unchanged for the entire year at a total return of just over 1%. This volatility continued into the New Year with a January swoon of 5%. Global oil prices declined 35% during 2015, aiding the consumer but having an acute impact on the profitability of oil and gas companies. For the year, the Consumer Discretionary sector had the strongest performance, up 10%. Meanwhile the Energy sector showed the weakest performance being down 21%. In December the Federal Reserve raised the Fed Funds rate for the first time in nine years. The ¼ of one percent increase ended an historic seven year period with the Fed Funds rate having hovered at as close to zero as possible. Real GDP Growth Real GDP was revised up to a 1.0% annual growth rate in Q4 beating the consensus expected revision of 0.4%, as reported by the Commerce Department on February 26 th. The largest positive contribution to the real GDP growth rate in Q4 was personal consumption. Real GDP increased 2.4% for the entire year of Nominal GDP growth real GDP plus inflation was revised up to a 2.0% annual rate from a prior estimate of 1.5%. The largest upward revisions were to inventories and net exports. Government purchases were revised downward. Nominal GDP grew 3% in 2015 and is up at a 3.5% annual rate in the past two years. All of these growth rates signal that a federal funds target rate of % is probably too low. Meanwhile, corporate profit margins are high and corporate balance

2 sheets are loaded with cash. A backdrop of share buybacks should also provide a safety net for equity markets. Employment Situation New claims for unemployment insurance were 272,000 according to data released on February 25 th. That marks the 51st consecutive week with initial Jobless claims coming in under 300,000. In other recent employment news, the unemployment rate fell to 4.9% in January. That puts the rate at an almost 8 year low. The largest pick-ups in payrolls were seen in the Retail and Health Care sectors. Personal Income and Consumption Personal income increased 0.5% in January. The consensus expectation was for a gain of 0.4%. Personal consumption also rose by 0.5% in January. The consensus expectation was for a gain of 0.3%. Personal income is up 4.3% in the past year, while spending is up 4.2%. Disposable personal income increased 0.5% in January and is up 4.0% from a year ago. The gain in January was led by private-sector wages and salaries. Most categories showed some gains. These are not numbers that suggest that a recession is imminent. Household spending grew at the fastest pace in nearly a year, with outlays on both goods and services increasing. Service spending rose 0.6% in January, boosted in part by spending on utilities, as cold temperatures returned in January after an unusually warm December. Meanwhile, purchases of durable goods, big-ticket items like cars and appliances, rose the most in eight months. The 4.2% rise in spending over the past year has not been due to some unsustainable credit binge. Rather, it reflects the higher purchasing power of the population. Personal income rose 0.5% in January, beating consensus expectations. It is up 4.3% in the past year. The increase in income has been led by wages and salaries in private service industries. Wages have risen across every major category. The PCE Deflator On the inflation front, the PCE deflator, the Fed s favorite measure for inflation, rose 0.1% in January. Although it s only up 1.3% from a year ago, it continues to be held down by falling energy prices. The core PCE deflator, which excludes food and energy, is up 1.7% from a year ago. That s also below the Fed s 2% inflation target, but the core PCE deflator is up at an annual rate of 2% in the past three months and we expect some acceleration in the year-to-year change in the year ahead.

3 As soon as energy prices stop falling, overall inflation should pick up. Together with continued employment gains, these data points support the case for at least one more Fed Funds rate hike in New Orders for Durable Goods New orders for durable goods rose 4.9% in January, well above the consensus expectation for a gain of 2.9%. Orders excluding transportation increased 1.8% in January, above the consensus expected gain of 0.3%. The rise in overall orders was led by aircraft and machinery, which showed the largest monthly gain for any month in three years. Boeing said that it had received 67 orders in January, 91% of them from within the U.S. No major category showed a decline. Durable goods rebounded sharply from a December drop. Orders for core capital goods orders rose 3.9%. Consumer purchasing power is growing with more jobs and higher incomes, while debt ratios remain very low, leaving room for a further boost to big-ticket spending. This is amplified by the significant drop in energy costs. The Consumer Price Index The Consumer Price Index (CPI) was unchanged in January, coming in above the consensus expected decline of 0.1%. The CPI is up 1.4% from a year ago. Cash inflation, which excludes the government s estimate of what homeowners would charge themselves for rent, was also unchanged in January, and is up 0.8% in the past year. Energy prices declined 2.8% in January, while food prices were unchanged. The core CPI, which excludes food and energy, increased 0.3% in January, above the consensus expected 0.2% rise. Core prices are up 2.2% versus a year ago. Real average hourly earnings, the cash earnings of all workers, adjusted for inflation, rose 0.4% in January and are up 1.1% in the last year. Real weekly earnings are up 1.2% in the last year. The CPI report shows inflation is percolating. While the headline reading displayed no change in overall consumer prices in January; the details of the report show why the Fed can be confident that inflation is moving back toward their 2% target. The reason consumer prices were unchanged in January was a 4.8% drop in gasoline prices, to the lowest level since March of Energy prices as whole were down 2.8%. But outside of the energy sector, prices rose almost across the board.

4 The core CPI, which excludes food and energy, rose 0.3% in January, led by housing and medical care. Owners equivalent rent, which makes up about ¼ of the CPI, rose 0.2% in January and is up 3.2% in the past year. It will be a key source of higher inflation in the year ahead. The core CPI is up 2.2% in the past twelve months and has been running above 2% annualized over the past 3, 6, and 12 month periods. Even including food and energy, there are some early signs of rising inflation, with consumer prices up 1.4% in the past year, versus an increase of 0.7% in the twelve months ending in December. When energy prices stop falling, overall inflation should move toward the Fed s 2% target. Producer Price Index Rose in January The Producer Price Index rose 0.1% in January, coming in above the consensus expectations of a decline of 0.2%. Producer prices are down 0.2% versus a year ago. The rise in producer prices in January was led by final demand services, up 0.5%. Energy prices fell 5.0% in January while food prices increased 1.0%. Producer prices excluding food and energy rose 0.4% and are up 0.6% in the past twelve months. In the past year, prices for services are up 0.9%, while prices for goods are down 2.6%. Prices for intermediate processed goods declined 1.2% in January and are down 5.4% versus a year ago. Prices for intermediate unprocessed goods dropped 0.7% in January and are down 17.8% versus a year ago. (This would primarily be fuel.) Leading Economic Indicators Point Downward The Conference Board s Index of Leading Economic Indicators decreased in January for a second month, reflecting a slump in stock prices and a pick-up in jobless claims (that has since reversed.) The Index, which measures the outlook for the next three to six months, dropped 0.2% in January after falling 0.3% the month before, according to data released February 18 th. Four of the ten indicators in the Index contributed to the decline in January, led by a sharp decline in stocks and an increase in claims for jobless benefits. Five of the ten contributed positively and one was basically unchanged. Following is a table of the ten components and how each has fared over the last six months: January Dec. Nov. Oct. Sept. Aug. Leading Index Monthly change -0.2% -0.3% 0.5% 0.5% -0.2% 0.0%

5 Interest rate spread 0.20% 0.22% 0.24% 0.22% 0.23% 0.23% Non def. Cap goods orders 0.11% -0.18% -0.04% 0.03% 0.02% -0.06% Average workweek 0.07% 0.00% 0.00% 0.00% -0.07% 0.00% Leading credit 0.03% 0.03% 0.08% 0.08% 0.03% 0.02% Ave. Consumer expectations 0.01% -0.02% 0.00% 0.01% 0.01% 0.04% Consumer goods orders 0.00% 0.15% 0.04% -0.06% 0.09% 0.02% Building permits -0.01% -0.19% 0.31% 0.15% -0.15% 0.08% ISM New orders -0.08% -0.14% -0.13% -0.09% -0.11% -0.08% Jobless claims -0.11% -0.07% -0.08% 0.06% 0.10% -0.09% Stock prices -0.27% -0.05% 0.11% 0.16% -0.19% -0.10% Manufacturing is Tepid On the manufacturing front, The New York Fed s Empire State Manufacturing Survey, the first reading on the U.S. factory sector in February, came out on the 16 th of the month and showed continued weakness with a reading of This followed a January reading of Meanwhile on the 18 th, the Philadelphia Fed index, a good measure of sentiment in East Coast manufacturing, came in at -2.8 in February versus in January. This showed that the rate of contraction in that region is also negative but is flattening out. The Richmond Fed Manufacturing Index clocked in on February 23 rd at minus 4, versus an expected reading of plus 2. At the Kansas City Fed, Manufacturing Activity reported on February 25 th showed a number that was a minus 12 versus an expected reading of minus 6. There seems to be a mid-winter s chill in the manufacturing sector of the economy. IBM Tops List of Patents for 23 rd Consecutive Year IBM received the most U.S. patents for the 23 rd consecutive year in In all, IBM was awarded 7,355 patents in the year, followed by Samsung Electronics, Canon Inc., Qualcomm and Google. Intel and Microsoft registered at 9 th and 10 th. More than 2,000 of IBM s patents last year were related to its cloud and cognitive computing. IBM consistently spends in the neighborhood of 6% of its annual revenue on research and development. The total number of patents granted dropped for the first time since 2007, from a 2014 high of 300,678 to 298,407 last year. The drop reflects a June 2014 Supreme Court ruling that made it harder to obtain patents on software and methods of doing business on the internet. On the plus side, inventions related image data processing and recognition saw increases. Patents awarded on the topic of self-driving cars, on-board entertainment and crash avoidance systems were also popular.

6 Now That s a Bond! When I say Perpetual what comes to your mind? Is it the endless cycle of sunrises and sunsets? Perhaps it is debates about the debt ceiling? Maybe right now it s political commercials? Well how about the interest on a bond?? Yale University was paid interest on a Dutch Water Authority bond that was issued back on May 15 th in the year The 1,000 guilder bond, which is written on goatskin, is one of the oldest bonds known to still pay interest. Yale s Endowment, which is valued in the neighborhood of $24 billion, bought the bond as an artifact in 2003 for 24,000 Euros. The University received Euros, or about $152.57, in interest that had accumulated since they had acquired the bond in If you were wondering, the bond was issued to pay for the repair of a dike in the Lek River in the Netherlands. It s not a pretty Tulip bulb, but hey, it still pays. Deja-Vu? Yogi Berra died in late September at the age of 90. A long-time New York Yankee, Berra was credited with popularizing the phrase, It ain t over til it s over. I guess it really is over now. For Yogi at least. Berra played in 14 World Series and was on the winning side 10 times, both records. He also holds the World Series records for at-bats (259) and hits (71). He was elected to the National Baseball Hall of Fame in He was probably best known, however, not for his ball playing records but for his near genius and yet convoluted way of repeating himself within the turn of a phrase. For example he was known to say, You can observe a lot just by watching. Or in a counter-positive fashion, I didn t really say everything I said. Describing a popular restaurant, he said, Nobody goes there anymore. It s too crowded. He was hilariously simple and yet almost to the point. After Mickey Mantle and Roger Maris hit back to back home runs in a 1961 game, he was heard to declare, It s deja-vu all over again! Berra will be missed by many. My favorite quote from the wayward wordsmith is this: When you come to a fork in the road, take it. McKim Williams, Jr. Chief Investment Officer February 29th, 2016 The opinions contained herein are those of McKim Williams, Jr. as of the date of publication and are subject to change w ithout notice. The contents have been compiled or derived from sources believed reliable. Old Point Trust makes no representation or w arranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions w hich may be contained herein and accepts no liability w hatsoever for any loss arising from any use of or reliance on this report or its contents. Old Point Trust, its affiliates and/or their respective officers, directors or employees may from time to time acquire, hold or sell securities mentioned herein.