Barn Burner

US equities closed out a barn burner week with more gains.

Media outlets variously attributed Friday’s rally, which capped the best week since 2020 (figure below), to soundbites from what one US official described as a “direct, substantive” call between Xi Jinping and Joe Biden.

In a statement, the White House said Biden outlined “the implications and consequences if China provides material support to Russia as it conducts brutal attacks against Ukrainian cities and civilians.” Multiple reports suggest the US believes Beijing is predisposed to assisting Moscow. Both the Kremlin and Beijing denied US assertions that Vladimir Putin requested military support.

In its own account of Friday’s call, China described Xi’s message to Biden. The invasion, Xi said, “is not something we want to see.”

Of course, “not wanting to see” something is different from promising not to support it once it’s already going on, especially when such support may be deemed expedient or conducive to furthering existing strategic alliances. It’s surely true that Beijing could exploit the situation given desperation at the Kremlin, and maybe the terms of any such deal are simply too favorable to China for Xi to pass up. Suffice to say the answer from Beijing to Putin almost surely wasn’t a flat “no.”

And yet, all “new world monetary order” frameworks aside, it’s far from obvious that China’s best move is to tether the country’s fate to Putin’s. The US has likely prepared a list of escalatory measures to impose in the event Xi decides the rewards of bailing out Russia outweigh the risks. Xi doesn’t need another mini-crisis right now, and the US could surely trigger one.

In any case, I wanted to reiterate that when you think about the four-session rally in US equities, you absolutely have to grasp what drove it from a mechanical perspective. “The potential for cratering US equities implied volatility would mean a profound vanna impact, as dealers would be buying back / covering their ‘short futures’ hedges held against customers who’ve been long index and ETF puts in size,” Nomura’s Charlie McElligott wrote Friday, calling the net delta add over the three-session surge covering Tuesday, Wednesday and Thursday “outright shocking.”

In SPX/SPY, for example, the three-day change was $550.4 billion (figure on the right, above).

It may seem repetitive, but this really is key to understanding what might otherwise seem like inexplicable price action. With puts bleeding into expiry, dealers kept covering hedges, and as McElligott noted Friday, clients increasingly prefer dynamic hedging in futures and ETFs given expensive options in an environment when vol is elevated. Those hedges are likewise “short squeeze fodder,” as Charlie put it, as they’re “just another form of (synthetic) ‘short gamma’ in the marketplace.”

At the same time, popular shorts ripped and, relatedly, recent losers turned into winners. Goldman’s profitless tech basked jumped 18% in five sessions (figure below), for example.

Although there’s an argument to be made that the hardest-hit segments are due for a rebound, there’s still a very compelling bear case for anything long duration.

Ultimately, it’d be a mistake to make too much of this week’s rally, even as exhausted investors will surely take it. There is scope for re-leveraging from the systematic community, and that could facilitate additional gains contingent, of course, on spot grinding higher and volatility subsiding further. CTA trend likely covered nearly $20 billion in global equities over the past several sessions, and vol control hasn’t even begun to re-risk yet.

Again, though, mechanical bear market rallies aren’t to be trusted. Especially not in an environment like this one. As McElligott noted Friday, even if there is a ceasefire in eastern Europe, “there currently is no tangible ‘off-ramp’ for Russia sanctions.”