Jim Cramer's 'Mad Money' Recap: Making Money in Spite of the Federal Reserve

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NEW YORK (TheStreet) -- With interest rates having been so low for so long, the stock market is in uncharted waters, Jim Cramer told his Mad Money viewers Friday, as he dedicated the entire show to demystifying the Federal Reserve and its many powers over the markets and the economy.

When the Fed cuts interest rates, it's trying to ignite the economy. Conversely, when it raises interest rates, it's trying to rein in the economy and ward off inflation. The key to investing, however, is sticking with long-term themes that make money no matter what the Fed is up to.

So how did the markets end up in no man's land? Well, after raising interest rates 17 times between 2003 and 2006, the Fed failed to adequately consider what those increases were doing to the housing market and how inextricably linked our economy is to housing. After an abrupt about-face, the Fed has since been doing everything it can to reignite our economy by cutting rates to near zero, then by buying bonds to lower rates even further.

Low interest rates affect the stock market in several ways. They stimulate hiring and spur consumer spending, from homes to autos to retail, all of which accounts for nearly two-thirds of our economy. Low rates also allow companies to expand and finance mergers and acquisitions.

So now that the Fed has done its job, the rest of the economy is beginning to take over.

Worry About the Dollar

Now that the Fed has switched its stance from from cutting interest rates to raising them, it has once again become the enemy of higher stock prices, Cramer told viewers. It can be a powerful enemy if it moves too quickly.

But while some believe the economy is too weak to handle even the slightest rise in rates, or that stocks will immediately lose their status as the only income vehicle worth investing in, Cramer said he doesn't see either of these as issues until there have been multiple rate hikes. After all, the U.S. economy has done quite well in the past with a 4%, 5% and even 6% federal funds rate and we're nowhere near those levels.

What does Cramer worry about? The strong U.S. dollar. Higher short-term interest rates will make the U.S. a magnet for money around the globe and that will only continue to hurt our exports. That's where the term "Don't fight the Fed" comes into play, Cramer noted, as those who have the Fed wind at their backs always come out ahead.

Don't Sell, Sell, Sell

With all of the Federal Reserve confusion, why not just sell all your stocks and go home? Cramer said the fact remains that stocks are still the best wealth creators out there over the long run. The key, he said, is to know which stocks work in a rising interest rate environment. That's not to say there aren't times to sell. That was certainly the case in 2007, just prior to the Great Recession when there was sizable systemic risk, but it certainly isn't the case now.

Cramer still advocated investing in index funds for those just starting out or those who cannot do the homework required with owning individual stocks. He also advised buying in increments, adding more in the months just before upcoming Fed meetings.

For younger people, the Fed won't matter much, Cramer said. They can invest in stocks with good growth and opportunities. Older investors however, should consider taking less risks and investing with more safety in a higher rate environment. Bond market equivalents can also become problematic, he added.

Get Ready to Rotate

What happens when the economy truly does begin to stand on its own two feet? That's when the sector rotations will begin, Cramer explained.

In normal times, investors would be reaching for the industrial stocks, those that will improve year over year as the economy gets better year after year. But in a world linked to global markets, these are no longer normal times. Even with the U.S., Europe and China on the mend, the industrials still have to contend with Latin America and other areas dragging down their earnings potential. Additionally, the industrials are getting clobbered by the strong dollar.

That means investors need a secular trend that is powerful enough to overcome the pull of global economy, like the bull market in aerospace, which is more dependent on the need for more fuel efficient planes and not the economy at large.

Investors need to consider stocks with limited overseas exposure, high growth stocks that aren't dependent on the economy and of course, the banks, which love higher interest rates. History is on the side of all these types of stocks, Cramer continued.

What about gold? Gold has been in a bear market seemingly forever now, and Cramer said he'd only trust Randgold (GOLD) or the SPDR Gold Shares (GLD)  exchange-traded fund.

Shorting Stocks

Cramer's final lessons for investors was on a topic he almost never covers on Mad Money, shorting stocks. Cramer's not a fan of betting against a stock, nor is he allowed to short stocks at his charitable trust, Action Alerts PLUS. That said, he dusted off some old rules from his old hedge fund days provided by Karen Cramer.

Rule number one: Never short a company you can imagine on the cover of a great publication. While the influence of magazines and big newspapers may be waning, the point is, never bet against a best of breed company.

Rule number two: Ask, can the company be taken over? If it can, then it's not a good short.

Rule number three: Never short a stock because it seems overvalued. You'll never be as adept at calling the top as you think you are and some stocks, like Chipotle Mexican Grill (CMG) , have valuations that defy gravity.

Rule number four: Never short with common stock when puts are available. For those not familiar with the options market, Cramer referred to his 2009 book, Real Money: Sane Investing in an Insane World.

Rule number five: Never short a stock if everyone else is shorting it, too. Those other guys will break ranks and leave you holding the bag every time.

Cramer's bottom line is, realize there's a lot more downside to shorting a stock than you might realize, unless you do it right.

To watch replays of Cramer's video segments, visit the Mad Money page on CNBC.

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At the time of publication, Cramer's Action Alerts PLUS had no position in stocks mentioned.

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