55% of American adults own stock investments, according to Gallup. But far fewer people trade corporate bonds, as the bond market is less liquid and harder to understand. Corporate bond investors must first understand the cash flow, the profit margin, the management of the company, and the prospect of the industry. In addition, they must also understand the contractual and structural seniority of the bonds, and the collateral, the guarantees, and the legal terms that safeguard the bonds.
Many investors don’t even bother to try. After all, it is stock that captures all the upside potential in the long run.
However, the bond market and the related legal terms sometimes have a substantial impact on the stock price. When legal loopholes in bond contracts are exposed, or when news about refinancing comes out, for example, they provide unique opportunities to stock traders that are well versed in bonds. The opportunities are bigger when companies are under stress, as the nuances of their debt financing may tip the balance of their survival, thus causing swings in stock prices.
On January 8, 2016, Scott Josefsberg, a legal expert from a renowned research firm, made a comment on Denbury Resources’ debt terms, explaining how the proposed terms of the new bonds had critical legal loopholes. The next two days, Denbury’s stock price dropped 14% from $1.63 to $1.41.
On July 1, 2016, iHeartMedia’s stock plunged 17% after financial experts Jack Kranefuss from a rating agency and Sarah Gefter from a research firm explained why it is getting harder for iHeartMedia to refinance its existing bonds.
On July 5, 2016, Duo Ai, a financial expert who lead a credit analysis software company, explained how Valeant Pharmaceutical’s management could boost its stock price at the expense of bondholders. The next day, Valeant’s stock price surged by 15%.
On all occasions, the stock prices moved gradually after the comments were published, indicating that some investors took more time to understand the implications than others. The ones that were better versed in bond terms could react faster and profit from the subsequent movements in stock prices.