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The Bondies vs. the Equity Gunners: An Interest Rate Parable

Cramer explains what the battle royal means.
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People don't want to believe interest rates matter. Much of the email I have been getting of late is of the "so what" variety, as in "so what if rates go up?" When I attempt to answer these questions in a calm and rational way, I get angered responses that accuse me of being a member of some recidivist Old Guard contingent, trying to block all progress in the name of the

Fed

.

First, I don't blame you for confusion. There is so much disinformation about the role of interest rates in the economy that it is easy to see why you might be baffled. Why, just this weekend there was an article in the

Times

suggesting that Net stocks get hit inordinately by rate increases because so many of them fund their operations with debt. Wrong! Other than

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, there is virtually no funding with debt. In fact, one of the reasons investors have gravitated to the Net is because the balance sheets of the vast majority of these companies have no debt of any kind!

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So, let's spend a little time going over the ongoing game for your money, as that's what's behind much of the tension that I see underneath the

NDX

selloff. First, just imagine two competing ball clubs. One ball club, the Bondies, regularly shoots 4% from the field. Another club, the Equity Gunners, sometimes shoots 20% and sometimes misses the basket altogether.

When the Gunners have a hot hand, you want to bet the farm on them. But when they are cold, what you wouldn't give for that slow, boring 4%. Now, let's say the Bondies can suddenly give you 5% instead of 4%. And let's say the Equity Gunners can actually take points away from you, egads -- negative scoring!!! The equation changes. The Bondies are giving you a 25% better return than you received previously. The Equity Gunners can hammer you.

In the contest of whom to bet on, knowing that you can lose more than your bet with the latter while getting a better return than before with the former, many people will switch to the Bondies.

Now, let's make it tougher. Let's say the people who control the odds are saying, look, if you play your cards right you could get 5.5% fairly risk free betting on the Bondies, courtesy of a rate hike. That's an even higher disincentive for the nation's capital to go to the Equity Gunners.

That's the main reason why rate increases drain money out of equities; the competition for your dollars just gets too fierce. That's what I fear occurring on Friday, when the employment number gets reported. I fear a changing of the odds. Of course, this is a simplified version of the match, with exaggerated rate skeds for both, and a kind of brutal synthesis of short and long rates to get the point across. But if you get the gist, that a rate hike makes short-term fixed income more competitive than in the past, then you understand what a formidable challenge the Fed can pose to equities.

Right now the Fed may have the hot hand. And you may have to bet with it -- and the Bondies -- against the stock market if the macro numbers stay too hot, as they were Tuesday.

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

jjcletters@thestreet.com.