(MONEY Magazine) – They're back. "It" stocks--the hot issues that defy all the laws of fundamental investing--have reappeared. These are the kinds of stocks that seem to keep heading higher for no other reason than that they finished higher the day before.

Search engine Ask Jeeves is up 570% in 2003. Money-losing XM Satellite Radio is up 400%. And unprofitable biotech ImClone Systems (better known for the insider trading scandal that landed founder Sam Waksal in jail) is up 300%. Sure, none are likely to surpass the 2,620% gain of quintessential "it" stock Qualcomm in 1999. But it's beginning to look as though investors are getting caught up in the momentum mania that characterized the final gasps of the bull market.

Just look at these stats: The Nasdaq has gained 29% this year (through July 30) and is up 54% from its Oct. 9, 2002 low. (Standard & Poor's 500-stock index is up about 28% from its low.) According to Thomson/Baseline, 119 companies with a market value of at least $500 million have doubled this year; nearly 40% of them are not expected to post a profit in 2003. And shares of companies (also with a minimum market value of $500 million) that don't pay dividends were up an average of 46% vs. a 16% average gain for those that do. "The companies that have run the most are the ones that have the least [to offer]," says Jeffrey Saut, chief investment strategist for Raymond James. "Speculation is back."

More evidence of the individual investor's renewed infatuation with risky stocks can be found at the website of online broker Ameritrade, which tracks the top 10 stocks bought by its customers every day. In late July the list contained a number of onetime tech darlings: JDS Uniphase, Lucent Technologies, Nortel Networks and Sun Microsystems, to name a few. And second-quarter trading volume at online brokers surged 40% over last year's second quarter. What's more, investors appear to be falling into the trap of buying these stocks on margin, that is, borrowing money from their brokers to pay for them. At online broker E-Trade, the level of margin debt in the second quarter rose 31% over the first quarter.

And according to fund tracking firm Lipper, investors are starting to put more money into tech funds following their big run-up of the past few months (funds like Amerindo Technology, Jacob Internet and MunderNetNet have all soared more than 50% through July 30). In the second quarter, tech funds recorded a net inflow of $335 million, with $250 million of that total coming in June. "There's definitely a little bit of performance chasing going on," says Don Cassidy, senior analyst with Lipper.

RELIVING PAST MISTAKES

It's all eerily reminiscent of the errors investors made during the last bull run--chasing after hot funds, buying highly speculative stocks on margin and expecting unrealistic triple-digit returns. Why have investors forgotten the lessons of the bear market so soon? Perhaps it's just that the pain has dulled over the years. Or that the allure of a rising market is too strong to resist. Still, the renewed frenzy among individual investors is merely a symptom of all this speculation. For blame, we have to look to the so-called smart money.

THE SMART SET LEADS THE WAY

Strangely enough, the bears, or short-sellers, are partly responsible for this spurt. Short interest on the Nasdaq (the number of shares being held by investors who are betting that stocks will fall) increased every month in 2003 except May and hit a record high in July. But as the broader market mounted its springtime rebound, many short-sellers were forced to buy back the stocks they had borrowed to sell short. So, as the market moved higher, the shorts became buyers of stock, in an effort to avoid mounting losses. That raised share prices of iffy companies further, a phenomenon known as a short squeeze.

Then add mutual fund managers, many of whom have been thirsting for gains after three years of bruising losses. Barry Ritholtz, chief market strategist for Maxim Group, a New York-based money-management firm, says that some managers may have felt they had no choice but to chase these hot names or else miss out on a big rally. Large mutual fund firms such as Alliance Capital, Dreyfus Investment Advisors and Vanguard Group all increased their stakes in one of the year's hottest stocks, Ask Jeeves, during the first two quarters of 2003, according to FactSet Research.

Short squeezes and momentum chasing can fuel the market for only so long, which is why investors need to tread carefully. Sooner or later, the big guns will cash in their gains and put the money elsewhere. And guess who'll end up holding high-priced duds? "These sort of speculative run-ups usually end up badly," says money manager Ritholtz. "Most individual investors aren't disciplined enough to cut and run when things turn south."

WIDESPREAD SUPPORT IS KEY

So what differentiates a speculative market from a bull market? "For this move to be sustainable and more rational, it has to broaden out and include companies that are more fundamentally solid," says David Joy, capital markets strategist for American Express Financial Advisors. With that in mind, Joy is looking for investing pros to start moving out of the year's big winners and into areas like basic materials, consumer staples and possibly even larger, profitable tech companies like IBM and Microsoft that have lagged smaller rivals.

So if you haven't joined the frenzy yet, now is not the time. It's never profitable being the last one to the market rally and the last to leave it.