The Markets Are Hostage to Hedge Funds

The fundamentals do matter, Cramer said Thursday, but often times not as much as hedge funds.

This was especially true today, as the Dow soared 273 points and the S&P 500 added a big 3%. Sure, the good news we got out of China, that its exports and imports were strong, certainly added to the move, but the real driver was the huge amount of cash that hedge funds wield and the way they employ it.

To explain, Cramer took viewers back to the sell-off that began in 2008. The beginnings of that drop started because oil, copper and the Baltic Freight Index peaked, signaling a slowdown in China. At that point the hedge funds were "all in" on the companies that benefited from a booming Chinese economy, leaving them little choice to but sell their holdings en masse in order to meet margin and redemption calls.

This sell-off rippled out, Cramer said, hurting virtually every other sector other than the financials. They, of course, were already struggling, with AIG , Washington Mutual, Wachovia, General Motors, Lehman Brothers, Fannie Mae and Freddie Mac collapsing at that time.

Then in 2009 China’s stimulus kicked in, and the hedge funds raced back to their original trades. As a result, the commodity futures rose, which in turn pushed up the sector exchange-traded funds and ultimately the S&P. It was this reversal, as well as all the initiatives pushed through here in the States – from Secretary Geithner’s bank stress tests to Federal Reserve Chairman’s monetary policy and President Obama’s stimulus – that lifted the Dow to 11,000 from its low of 6,500 that March.

But then three months ago, with China’s economy seemingly overheating, the Chinese government felt the need to slow things down. When oil and copper fell soon after, the hedge funds once again dumped their holdings, fearing a repeat of ’08. That resulted in the worst May in 40 years.

And now we’re back to this week, where the news out of China is positive. Hence the hedge funds piling back in and generating gains in the averages like those we saw today.

“I know, it’s just crazy,” Cramer said. “But it’s all them – believe me.”

Cramer blamed this craziness on hedge funds’ need to deliver results on a day-to-day basis. They literally have to report their results every day. And those who don’t perform risk losing clients.

Plus, the power of these funds is magnified by leverage, or easy credit from brokerage firms. Cramer ran a $500 million hedge fund, but his brokers would lend him $250 million on top of that. Add in these new double- and triple-leveraged ETFs and a similar fund could potentially put $2.25 billion to work in the market at any given time. That fund will use it all, too, because of the pressure to perform. And there’s no way anyone – retail investors, pension funds, mutual funds or index funds – can compete with that firepower.

So what’s the takeaway?

“We’re hostage to hedge funds sometimes,” Cramer said.

Call Cramer: 1-800-743-CNBC

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