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Ripple effects have influence broader bond market

The bond market is largely out of reach for day traders, unless through a proxy, so it would seem safe from the dynamics that have launched volatility in equities like GameStop Corp.

But it's not, exactly.

The stunning ascent this month of GameStop $(GME)$, AMC Entertainment Holdings Inc. $(AMC)$ and other heavily shorted stocks targeted by day traders huddled in online forums in a battle against Wall Street short sellers has been met by lofty moves for the company's corporate bonds too.

While individual investors using Reddit's WallStreetBets or other online forums still have little direct influence on the broader debt markets, speculative stock-buying can cause real ripple effects.

"There is very little individual investor presence in the corporate bond market," said John McClain, portfolio manager at Diamond Hill Capital Management, but he also pointed to the "GameStop side effect," namely, that skyrocketing stock prices can trigger a company to issue shares and use that money to strengthen a balance sheet, boost its liquidity position or to pay down existing debt.

"If the equity of GameStop goes parabolic," McClain said, it can significantly boost the company's market capitalization, and "in theory, the debt is somewhat better protected."

The problem, McClain argued, is that the co-mingling of pandemic stimulus from policy makers and the rise of commission-free stock apps that allow anybody to trade equities with a swipe can lead to real risks for individual investors, while creating headaches for debt-market participants.

"The casino is open and everybody is invited in," McClain said. "It's free booze and basically free chips."

This chart shows AMC's bonds not only rallied in January, but were the most actively traded debt from a list of Russell 3000 Index stocks included in MarketWatch's short squeeze list for 2021:

AMC bonds, while still under pressures due to the pandemic, have garnered $2 billion worth of trades since the beginning of January, according to debt tracking platform BondCliq.

At last check, its popular 12% bonds due in June 2026 were fetching prices of $73.50, up from $23.99 on Jan. 6, according to BondCliq.

Some cold water was splashed on surging GameStop and AMC shares on Thursday, after several brokerages limited buying and lawmakers called for new restrictions.

But they bounced back in extended trading after online trading platform Robinhood said it would "allow limited buys" of GameStop and other volatile stocks beginning Friday.

Read: GameStop, AMC stocks bounce back after Robinhood says it will allow some buying Friday

At Thursday's close, AMC's stock still was still up 300% year to date, according to FactSet data.

For its part, AMC has already raised $600 million as some its outstanding 2.95% notes were converted to 44.4 million shares at a conversion price of $13.51 a share, holdings which slid 30% in a matter of hours as brokerage restrictions limited trade.

See: Investors that converted AMC bonds to stock see value of holdings slide 30% in a matter of hours

Even so, John Flahive, head of fixed income investments at BNY Mellon Wealth, said he still sees a limited overall impact in the broader bond market from recent ructions in equity trading, pointing to 10-year Treasury yields holding around 1.06%.

"Could they use the equity market as a source of capital?" Flahive asked. "Theoretically, they could do that. But given the volatility in the marketplace it would be viewed as unlikely."