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The bright spot in strained bond markets

The bright spot in strained bond markets
The bright spot in strained bond markets

Troubled companies are thin on the ground these days. That has been good news for investors in an important corner of the financial system.

Owning the debt of the riskiest companies in the US and Europe has provided positive returns so far this year for fixed income investors, a rare bright spot in the vast universe of publicly traded debt.

By contrast, holders of higher quality bonds sold by governments and companies have experienced negative returns during 2021. That has been driven by expectations of higher interest rates as inflation and economic growth pick up. As rates rise, existing bonds are less attractive to investors compared with new debt offerings.

The disparity in performance between high and lower quality debt may appear strange given that the overall rise in bond yields this year might be expected to hit strained companies more. An explanation rests in how markets behave once an economic recovery is under way.

As corporate default risk abates, shares and debt sold by so-called “junk-rated” companies with lower quality balance sheets rally sharply — as was seen in 2009 and 2003 when high yield appreciated sharply in value in the wake of defaults peaking and recessions ending.

“Default rates have fallen a lot and companies have refinanced their debt at lower rates and if we get the expected rebound in profits, high yield can hold up into next year,” says Adrian Miller, chief market strategist at Concise Capital, an asset manager specialising in small company debt. 

Indeed, this week, Fitch Ratings forecast a decline in the expected rate of speculative rated company defaults this year to 2 per cent from 3.5 per cent in 2021. The pace of defaults has eased markedly from a projected 5.2 per cent a year ago and is nowhere near the peak of 14 per cent seen in 2009.

With reduced fear of default, the higher fixed rates of borrowing that are paid by lower quality companies suddenly look attractive compared with the relatively meagre offerings by blue-chip rated bonds.

This week, BlackRock said demand for income in the high-yield market from investors contributed to their strong client flows during an impressive first-quarter performance by the asset manager.

The need for income helps explain another oddity about the current high-yield market. The risk premium or spread associated with owning the lowest quality credit has shrunk markedly versus that of US government bonds.

The spread has eased towards the lowest levels seen during the post financial crisis decade. Moreover, it has occurred after a record $140bn of junk bond debt was sold during the first three months of the year. Bank of America forecasts $475bn of debt sales in 2021, a 10 per cent increase from a record-breaking 2020.

The ability of companies to raise debt in such amounts and not send interest rates markedly higher reflects the seemingly insatiable demand for income by investors betting on defaults staying low with a robust global economic recovery in the wake of the pandemic.

Column chart of US high yield debt showing Fitch forecasts improving outlook for US corporate defaults in 2021

Still, the speed and extent of the rally in high yield debt does little to allay long term concerns that the credit market has run well ahead of underlying fundamentals for low quality companies.

It comes amid a low rate of capacity utilisation by US companies. In previous decades, this reflected plenty of slack in the economy and thereby indicated mounting challenges for companies. 

Marty Fridson, chief investment officer at Lehmann Livian Fridson Advisors, says there is hidden distress in the high-yield debt market. He says that even better rated companies have been pushed beyond fair value on the back of the huge support by the US Federal Reserve for markets and the flow of credit.

That Fed intervention should leave investors wary about the eventual longer term consequences. There remains considerable doubt as to the extent of the post-pandemic recovery beyond this year for indebted companies.

Fitch, for example, has a slightly higher 2022 default rate forecast than this year, “reflecting uncertainty around the sustainability of the demand recovery for some sectors”. This is partly due to the persistence of digital trends that has challenged a number of sectors.

Tracy Chen, portfolio manager at Brandywine Global, an investment boutique of Franklin Resources, says: “Business models will change after Covid and there are still a lot of companies being supported by accommodative policies.

“Stimulus and infrastructure spending is good for certain sectors. Longer term we are less bullish on high yield.”

This view reflects doubts as to whether stimulus provides some companies with a new lease of life, or delays an eventual debt reckoning.

“Prior to Covid, investors were very cautious about credit and talking about the end of the cycle,” says Chen.

“There is a case that a bigger default cycle has been delayed and that it occurs over the next 12 to 18 months, once the stimulus measures have ended.”


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Great auto-themed products to splurge on this week

Great auto-themed products to splurge on this week
Great auto-themed products to splurge on this week

This week’s auto-related items include a no-mess funnel, a road map duvet set and a vehicle load extender.

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Inflation wild card unsettles markets

Inflation wild card unsettles markets
Inflation wild card unsettles markets

Regime changes usually take a while to fully register among investors. The big talking point in markets at the moment surrounds the potential return of a more troublesome level of consumer price inflation and what protective action investors should take.

The underlying trend of inflation matters a great deal for financial markets and investor returns. The rise in both equity and bond prices in recent decades has occurred during a long period of subsiding inflation pressure and from recent efforts by central banks to arrest disinflationary shocks since the financial crisis. 

A year after the global economy abruptly shut down, activity is duly picking up speed. The logical outcome has been a surge in readings of inflation and this week, a measure of US core prices recorded its largest annual gain since 2008, running at a pace of 4.2 per cent.

Core readings exclude food and energy prices and are deemed a smoother gauge of underlying inflation pressure, a point that many people outside finance find baffling when budgeting the cost of groceries and petrol.

So the significant jump in the core measure, and even accounting for the base effect of the pandemic’s brief deflationary shock a year ago, has understandably generated plenty of noise.

This will remain loud in the months ahead as activity recovers from lockdowns with a hefty tailwind of fiscal stimulus working its way through the broad economy.

But muddying the waters for investors is that the outlook for inflation is still difficult to judge at this stage.

“There is so much dislocation in the economy from the reopening and base effects from a year ago that it will take at least six to 12 months before we get a clear view of the underlying inflation trend,” said Jason Bloom, head of fixed income and alternatives ETF strategies at Invesco.

Investors who are now worried about an inflation shock face a dilemma. Some assets seen as traditional hedges against such a risk, like inflation-protected bonds and commodities, have already risen appreciably. Effectively a period of inflation running hot has been priced in to some degree.

And history does provide a cautionary note for those moving late to buy expensive inflation protection.

Past inflationary alarms, as economies recovered in the wake of the dotcom bust in the early 2000s and the financial crisis of 2008, proved false dawns. After a mercifully brief pandemic recession, the powerful and well entrenched disinflationary trends of ageing populations and falling costs associated with technological innovation are by no means in retreat.

For such reasons, a number of investors and the US Federal Reserve expect inflationary pressure this year will prove “transitory”. But stacked against deflationary forces is the immense scale of the monetary and fiscal stimulus of the past year.

The effects of monetary and fiscal stimulus means “inflation may settle into a pace of 2.5 per cent (annualised) and that would be different from the average of 1.5 per cent before the pandemic”, said Jason Pride, chief investment officer of private wealth at Glenmede Investment Management. “Inflation will be higher. At a dangerous level? No.”

In an environment of firmer growth and moderate inflation pressure, equities will benefit, led by companies that have earnings more influenced by the economic cycle. Investors also will seek companies that have the ability to pass on higher prices to customers in the near term and offset a squeeze on profit margins.

Still, a troublesome period of elevated inflation cannot be easily dismissed. The “transitory” argument could be challenged if economic growth continues to run hot into next year, accompanied by a trend of higher wages from companies finding it hard to attract workers.

Before reaching that point, expected inflation priced into the bond market may well push past the peaks of the past two decades and enter uncharted territory in the US and also for other developed markets in the UK and Europe.

Bond market forecasts of future inflation pressure over the next five to 10 years have already risen sharply in recent months. But the rebound is from a low level and for now, expected inflation is not far beyond the Fed’s long-term target of 2 per cent.

“It is the change in inflation expectations that drives asset returns,” said Nicholas Johnson, portfolio manager of commodities at Pimco. Assessing almost 50 years of data, a portfolio holding equities and bonds underperforms during bouts of elevated inflation, while real assets including inflation-linked bonds and commodities prosper, according to the asset manager.

“Most investors have not experienced a period where inflation surprised to the upside,” added Johnson. Clients are asking more questions about insulating their portfolios, but their present exposure to commodities and other assets show that in broad terms investors are “not paying much of an inflation premium”.

That can change and the prospect of inflation regime change remains a wild card for investors.

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Investors fret at prospect of new era of inflation

Investors fret at prospect of new era of inflation
Investors fret at prospect of new era of inflation

Please share this newsletter with friends and colleagues who might find it valuable and let them know that, even if they are not subscribers to the Financial Times, they can read the newsletter — and all of the FT — free for 30 days. Welcome and please sign up here.

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Fears of a summer of inflation intensified this week as the US consumer price index leapt unexpectedly to 4.2 per cent, spooking already anxious investors who worry that the Federal Reserve will put the brakes on its emergency bond-buying programme.

The increase, the highest jump in the year-on-year figure since 2008, was followed yesterday by a higher than expected increase in US producer prices. Meanwhile, producer prices in China, another closely watched indicator for global investors, rose 6.8 per cent year-on-year in April, its fastest pace of growth in more than three years. In the eurozone, inflation hit 1.6 per cent in April, according to initial estimates, and could get close to 2 per cent later this year.

As our latest Big Read points out, inflation targeting has since the early 1980s been a key aim of central bankers who would increase interest rates as soon as consumer prices looked to be on the up. But in recent times, Fed officials have been at pains to downplay inflation rises as a “transitory surge”.

Similar views have been expressed across the Atlantic. The European Central Bank’s Olli Rehn told the Financial Times this week that the ECB should follow the Fed’s lead by accepting an overshooting of its inflation target to make up for years of listless price growth. Minutes from the bank’s latest policy meeting, released this afternoon, said eurozone growth and inflation were more likely to surprise on the upside, suggesting the future of its bond-buying programme could be on the agenda at its next session in four weeks’ time.

As the FT Editorial Board points out, low inflation cannot be taken for granted. But the almost comical reaction to the idea that interest rates and inflation might have to rise at some point highlights just how thin-skinned some investors have become and how policymakers need to choose their words very carefully, argues markets editor Katie Martin.

As one investment officer tells her, bears need to end their perpetual fretting that the world is coming to an end: “The reality is that the only question that matters is whether the reopening is going OK or not. And it’s going OK. ”

Global economy

One group that has profited mightily from the pandemic is the global billionaires club. Much of the $9tn in government rescue funds has ended up via financial markets in the hands of the ultra-rich. According to Forbes magazine’s annual rankings, the number of billionaires increased to more than 2,700 over the previous 12 months, with total wealth rising $5tn to $13tn.

The super-rich have increased their wealth during the pandemic. Chart showing Billionaires’ wealth as a % of GDP. Russia comes out on top at almost 35%

New US jobless claims have fallen to a new pandemic low as employers step up hiring as the economic recovery takes hold. Many companies, including McDonald’s and other fast-food chains, are struggling to recruit workers.

Our Big Read discusses the political and economic ramifications of India’s Covid-19 crisis and Prime Minister Narendra Modi’s pandemic management as some experts put the true number of new daily infections at up to 2m and deaths as high as 50,000. Much of the criticism of Modi is coming from the country’s previously supportive urban middle classes.

Bar chart of Estimated number of people in each income tier in 2020 before and after the global recession (m) showing The pandemic sets back growth of India’s middle class


Amazon’s announcement today of 10,000 new UK hires is the latest sign of ecommerce’s forward march at the expense of bricks and mortar stores. The company’s net sales in the UK jumped 50 per cent last year to $26.5bn. Read our new series on the future of retail.

Apple supplier Foxconn has bounced back strongly after the pandemic lockdowns of its factories in China last year, reporting a 13.5-fold jump in net profit for the first quarter to NT$28.2bn ($1bn).

More than 60m travel and tourism jobs and $4.5tn in income were lost last year because of the pandemic, according to an industry report, meaning the sector’s contribution to global GDP fell to 5.5 per cent from 10.4 per cent in 2019. Airbnb chief Brian Chesky however told the FT the “travel rebound of the century” was on its way, fuelled by a strong recovery in the US holiday market.


Prices for steel ingredient iron ore, which have rocketed recently on prospects for a global economic recovery, came crashing down today after signs that China was about to crack down on speculative activity. Reports said local government in Tangshan, China’s main steelmaking city, would examine illegal behaviour and suspend production at mills found to be manipulating market prices.

Emerging markets correspondent Jonathan Wheatley looks at prospects for EM investors as the global recovery consolidates, including exchange traded funds and opportunities in China and its fellow “Brics” — Brazil, Russia and India.

Line chart of Indices, in $ terms (rebased) showing Emerging market stocks have underperformed the US market

Hedge funds involved in merger arbitrage — buying shares in M&A targets and betting against the acquirer, making money as the deal closes — took a pasting during the period of pandemic turmoil dubbed “arbageddon”. They are now however hoping to profit from a new surge of M&As as economies reopen: the first quarter of 2021 was the best start to a year’s M&A activity since at least 1980.

Have your say

Chris Wiles comments on Johnson looks at swift easing of homeworking rules in England:

Working in the office isn’t just about getting the job done but it’s also about being ingrained in the company’s culture, values and bouncing those ideas off other people which fuels the innovation and employees’ growth. The reality is businesses need to create office environments that motivate staff to want to work there, some creative alternatives to the old fashioned office style. Maybe the government should offer businesses a subsidy similar to the super tax-deduction for businesses to recreate their office environments. If they do that, it won’t be a case of ordering staff back to work, instead the staff will see the value of being in the office environment created and be more motivated to work there. Both an economic and perhaps innovation bonus would come from it

Final thought

“It’s going to be like New Year’s Eve in Trafalgar Square, but without the smell of Heineken.” UK editor at large Robert Shrimsley has mixed feelings about the return of hugging as social distancing regulations are relaxed and the “great reacquainting” looms.

©  Lucas Varela

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Renault and Nissan step up race with Tesla over powering electric cars

Renault and Nissan step up race with Tesla over powering electric cars
Renault and Nissan step up race with Tesla over powering electric cars

Renault and Nissan aim to be among the first carmakers to sell 1m electric vehicles using their joint battery system, putting them alongside Tesla and Volkswagen as industry leaders.

Luca de Meo, chief executive of the Renault, made the forecast this week at the FT’s Future of the Car Summit, adding that the partners were in talks to standardise the battery modules used in their electric cars.

It is a sign that the often-fractious alliance is finally healing under new management after the departure of the partnership’s former boss Carlos Ghosn, arrested in 2018 for financial misconduct charges.

“If we manage to come up with a very synergetic approach on battery, the alliance would probably be one of the first to cross the threshold of a million cars sold on the same battery module,” De Meo said.

Reducing complexity and cost is key for carmakers as they try to reduce the price of battery cars, while raising the profit margins they make selling them.

At present, Renault and Nissan source batteries separately, but Nissan’s chief operating officer Ashwani Gupta said the next generation of technology would be “a common battery” for the alliance, which also includes Mitsubishi.

“If we do a battery for 10m cars with the same chemistry, same structure, same sourcing, it will definitely be moving forward,” he told the virtual summit.

The alliance plan puts the groups within touching distance of VW, which plans to sell 1m electric or hybrid cars this year, although only half of those will be battery-only. 

Tesla, which only sells electric cars, is ramping up production of its electric vehicles after coming close to delivering 500,000 units last year.

Senior executives from Ford and Stellantis also warned about pricing motorists out of cars by moving too fast towards electric vehicles at the three-day FT event.

Ford’s European president Stuart Rowley said that a wider collaboration was needed with government, energy companies and charging groups in order to drive wider adoption of battery cars, as well as the need to lower the price so that current car buyers can afford the models.

“It has to be led at the ministerial level, but it needs to involve local governments as well as national, utility providers and industry participants,” he said.

“If we are not successful, people are going to keep hold of older vehicles, more polluting vehicles. We can’t leave people behind.”

There were also warnings of a squeeze of clean materials needed to make batteries, if carmakers continued to pull forward their ambitions to decarbonise the fleet.

As carmakers try to source materials in a decarbonised way, Tomas Nauclér, from McKinsey, told the FT event he expected a risk of shortages of clean-sourced parts.

He expected shortages of materials such as lithium, cobalt and nickel or iron ore for steel in the second half of this decade, as the new processes for reducing emissions from extraction or processing mean miners struggle to pump out enough to meet the demand expected from soaring sales.

“We are going to see a green materials squeeze in the second half of this decade, most likely, and possibly even into the next decade,” he said. “The next five years will be decisive whether we will see enough supply coming fast enough.” 

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US day trading frenzy eases as investors ‘move on to other things’

US day trading frenzy eases as investors ‘move on to other things’
US day trading frenzy eases as investors ‘move on to other things’

The day trading bonanza that took Wall Street by storm early in 2021 has cooled sharply as US authorities lift social curbs and amateur investors spend more time away from home.

An army of have-a-go traders armed with no-cost trading apps propelled “meme” stocks to lofty heights in the first months of this year, in a move so vigorous it prompted a Congressional inquiry into core market issues like trade settlement, and the links between brokers and market makers.

But as large portions of the US economy begin to reopen, data have begun to signal a fading appetite for the same type of intense trading that triggered volatility in many shares in January and February.

“The rise was spectacular, but the fall has been equally spectacular,” said Steve Sosnick, chief strategist at Interactive Brokers. “The casual investor, or the investor who conflated gambling with investing, they’ve moved on to other things. More people are heading back to the office . . . and quite frankly investors have other things to do with their money.”

In US options markets, where traders place sometimes risky bets on movements in stocks and other assets, trading associated with retail investors compared with overall volume slid to a six-month low of 15.5 per cent in early May, from close to 20 per cent in January. In April, total trading volumes across the retail brokerage sector were down 26 per cent compared with March, according to a Piper Sandler analysis.

Line chart of Percentage of small lots (1-10 contracts) of total call options showing Retail-linked plays in the options markets have been slipping

At the same time, the proportion of trades routed to market makers by the biggest retail brokerages, compared with overall US equity market volume, dropped 10 percentage points to 18 per cent between December and March, despite a fresh round of stimulus funds hitting American bank accounts at the latter portion of that period.

The slowdown in DIY trading marks a shift from earlier in the year when stocks like GameStop, which were hotly discussed on Reddit and other forums and were the subject of social media jokes, were sent surging higher by at-home investors. The moves were so strong that they inflicted heavy losses on hedge fund Melvin Capital, run by a protégé of well-known manager Steve Cohen. Congress has held numerous hearings over the episode.

The cooling in equity trading has coincided with a sharp rise in cryptocurrency activity, with volumes at major exchanges soaring to a record $1.7tn last month, according to CryptoCompare data compiled by The Block Crypto. However, analysts said a lack of granular data on crypto trading makes it difficult to determine the extent to which users of traditional retail trading platforms have shifted to digital assets.

Line chart of Price of Goldman's basket of 50 most popular retail stocks is coming down showing Popular retail stocks  are starting to drop after dramatic rally

Stocks favoured by retail traders have lost traction in recent weeks. A Goldman Sachs basket of popular retail picks, which includes the likes of Tesla, Apple and Zoom, has slid more than 12 per cent off its March peak.

Speculative trading in higher-risk penny stocks, which trade outside of most national stock exchanges and are a bellwether for retail day trading activity, has plummeted since its February highs. Volumes on over-the-counter markets halved to 928bn shares traded in April compared with February highs, according to data from the Financial Industry Regulatory Authority. 

Following severe market tumult early in 2020, equities have been on a mostly smooth path higher, and “that tends to be a time where you get more retail interest,” said Brian Nick, chief investment strategist at Nuveen.

Runaway Markets

In a series of articles, the FT examines the exuberant start to 2021 across global financial markets

However, equities wobbled this week, with the Nasdaq Composite, an index heavy with tech names favoured by retail investors, sliding 2.6 per cent on Monday and another 2.7 per cent on Wednesday. The two days were among the benchmark’s worst this year.

The Nasdaq is now down about 6 per cent from the record high it reached on April 29, while the broader S&P 500 is off about 2 per cent from its May 7 peak. If these losses accelerate more substantially, investors could start getting hit with margin calls on trades that are amplified using leverage, said Randy Frederick, vice-president of trading and derivates at Charles Schwab. Brokers demand customers put up more collateral to backstop the trades and keep it open. But a sudden rush of calls can sometimes sharpen market falls as investors sell other assets to meet the broker’s request.

The level of margin debt in brokerage accounts almost doubled between March last year and this year, to an all-time-high, according to Finra data. The data do not differentiate between amateur and professional investors, but “retail traders . . . probably have a tendency to overextend themselves,” putting them potentially more at risk, said Frederick.

Column chart of Share of brokerages' trades compared with overall US equity volume (%) showing Trades booked by retail brokerages are becoming less of a force

While the frenetic activity has eased off, volumes still remain elevated from a longer-term standpoint due in part to retail broker industry innovations, analysts said. One key element was a move by most US brokerages to drop commissions in late 2019, something that is credited with helping to fuel the rise in activity during the pandemic.

“As we saw during the pandemic, [retail investors] can be a big force,” said Katie Koch, co-head of fundamental equity at Goldman Sachs Asset Management. Post-pandemic, amateur trading “may not be at the same level of hyperactivity. But I expect the activity to remain elevated.”

Additional reporting by Eric Platt

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Global stocks endure worst week since February

Global stocks endure worst week since February
Global stocks endure worst week since February

Global stocks experienced the worst week since February after a choppy period where a US inflation scare and fears of tighter central bank policy were juxtaposed with bullish forecasts on the global economic recovery.

The FTSE All-World index of large-cap shares rose 1.6 per cent on Friday but ended the week 1.5 per cent lower, its worst performance in almost three months.

On Wall Street, the S&P 500 was up 1.5 per cent at the close in New York, its biggest weekly drop since February after reaching a record last Friday. The tech-heavy Nasdaq Composite index climbed 2.3 per cent but was still 2.3 per cent lower for the week.

Data on Wednesday showed US inflation rose 4.2 per cent year on year in April, sending shares tumbling worldwide as fears increased that the Federal Reserve would step in to prevent the economy overheating by tightening borrowing costs.

Fed policymakers have said that jolts of inflation are likely to be transient as the effects of last year’s lockdown restrictions work their way through the economy.

“We need to be patient, steely-eyed central bankers, and not be head-faked by temporary data surprises,” said Christopher Waller, a Federal Reserve board governor, this week.

Column chart of FTSE All-World index, weekly % change showing worst week for global stocks since February

A partial recovery across global stock markets on Thursday and Friday showed investors believed that “buying into dips is the right strategy because it has served them very well over the past year”, said Sunil Krishnan, head of multi-asset funds at Aviva Investors. “If you believe in what monetary policymakers are saying, then it is the right thing to do.”

However, if inflation “is not that far below 3 per cent in a year’s time, you can’t escape the gravitational pull on real purchasing power for too long”, he warned.

On Friday, the University of Michigan’s monthly survey of consumer sentiment showed households expected inflation to hit 4.6 per cent this year, up from 3.4 per cent when they were questioned in April. A sentiment index produced by the university also fell to a reading of 82.8 in May, down from 88.3 in April.

US Treasury bonds, which have increased in price over the past two New York sessions as investors shrugged off the inflation jitters, continued to rally on Friday.

The yield on the benchmark 10-year Treasury, which moves inversely to its price, fell almost 0.04 percentage points to 1.63 per cent.

In Europe, the Stoxx 600 regional share index closed up 1.2 per cent, capping off a volatile week with a 0.5 per cent loss.

Line chart of Cboe Volatility index showing volatility expectations jump for Wall Street stocks

Kasper Elmgreen, head of equities at Amundi, said he was “cautious” about the stock market in the near term because much of the developed world’s recovery from coronavirus was already baked into share valuations.

“After we’ve all had our first haircut and our first pint inside, what comes next?” he said, pointing out that China’s early economic rebound from the pandemic was followed by a stock market correction in late March, as traders banked gains and anticipated inflation.

The dollar index, which measures the greenback against a basket of big currencies, fell 0.35 per cent after US retail sales growth unexpectedly stalled in April. The euro rose 0.5 per cent against the dollar to purchase $1.2143. Sterling rose 0.3 per cent to $1.4094.

Brent crude, the international oil marker, climbed 2.5 per cent to $68.71 a barrel.

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