The fervor returns! Tech stocks lead the rise in risk assets, and retail investors are back in force. What does this signal?

The earnings season for the second quarter of US stocks followed the expected weak economic data. For the hot stock market, the hawkish tone of the Federal Reserve is like a passing breeze.

In fact, upon careful observation of today's US stock market, it is not difficult to see that the Federal Reserve's interest rate hikes have essentially been in vain. The bear market of 2022 has already passed, and the market has returned to the frenzy of 2021.

There are two main signals: 1) the exuberant rise of technology stocks; 2) the resurgence of retail investors. All of this is reminiscent of 2021, but at that time it was followed by a devastating crash.

Exuberant Rise of Technology Stocks

Looking at the overall market, the Federal Reserve's 500 basis points of interest rate hikes have had little impact.

16 months ago, when the Federal Reserve began this round of interest rate hikes, the S&P 500 closed at 4358 points. This Tuesday, the S&P 500 closed at 4555 points, even higher than when the interest rate hikes started.

The main driving force behind the rise in the index is the large-cap technology stocks that have experienced an exuberant rise this year.

The "Magnificent Seven," consisting of Apple, Microsoft, Google, Amazon, Nvidia, Tesla, and Meta, have seen their total market value soar by 60% so far this year, reaching an astonishing nearly $11 trillion, roughly equivalent to three times the GDP of Germany, the world's fourth-largest economy. The Magnificent Seven currently account for 28% of the total market value of the S&P 500, higher than the 20% at the beginning of the year.

Funds tracking the S&P 500 amount to approximately $15 trillion, which means that if one or two of these seven companies encounter problems, it could cause a huge shock to the market.

However, some market participants believe that similar narrow-led rallies have occurred in the past and lasted longer. This year's surge can also be seen as a reversal of the downturn in 2022, rather than a precursor to a crash.

Gillian Wolff, a senior analyst at BI, previously told Bloomberg News that the situation of the Magnificent Seven leading the market is not alarming:

"Unlike the dot-com bubble era, most of these companies have strong profit prospects. However, the upcoming earnings reports in the next few weeks may play a decisive role."

Resurgence of Retail Investors

The latest retail investor fund flow data from Vanda Research shows that retail investors in the US stock market are rushing to enter the market, mainly through US technology stocks, electric vehicles, bonds, and a wide range of stock ETFs, to continue chasing the rise.

Vanda Research expects that throughout the earnings season, the net buying volume of retail investors will remain high. The institution pointed out that retail investors tend to engage in "contrarian investing," that is, "buying high and selling low." If the stock market continues to rise, it is expected that a large amount of retail investor funds will flow in.

According to the institution, "retail traders have never been so actively buying stocks before the 'official' start of the earnings season" since the significant increase in the number of retail investors in the US stock market in 2020.

The Bank of America fund manager survey also shows that despite institutional investors' preference for underweighting stocks, according to data from the American Association of Individual Investors (AAII), retail investors' bullish sentiment towards the stock market has reached its highest level since 2021.

Retail investors' buying spree is driving the skyrocketing of meme stocks, which are widely loved by the American public.

So far this year, the MEME ETF has risen by 61%. Among the star meme stocks, there are some super winners with gains that outperform Nvidia: Bitcoin miner Riot Platforms has risen by 439% cumulatively, AI lending platform Upstart Holdings has risen by 308% cumulatively, Coinbase has risen by 196% cumulatively, and electric vehicle stock Carvana has risen by 740%.

In addition, Bitcoin has also seen a surge of 80% this year.

All sentiment indicators point in a positive direction:

The bull-bear spread, which is the difference between investors who believe the stock market will rise and those who expect it to fall, has been positive for six consecutive weeks. This is the longest period of positive bull-bear spread since November 2021.

Americans are also becoming more confident in the overall economy. According to the University of Michigan's survey, the consumer confidence index for July jumped from 64.4 last month to 72.6. This is the highest value since September 2021 and the largest increase since 2005.

Investor panic has largely subsided. The Cboe Volatility Index (VIX) is currently around 13, which means that the market has a low demand for insurance when the index is below 20. Data from the Chicago Board Options Exchange shows that the ratio of put options to call options has dropped to the lowest level since January 2022.

David Wagner, portfolio manager at Aptus Capital Advisors, told The Wall Street Journal that investors' concerns have diminished significantly since the Federal Reserve's bailout of the banking system in March. He believes that the only thing that can stop this upward trend is the reintroduction of significant risks. However, market participants who are bearish on the US stock market believe that a perfect storm for a comprehensive collapse is brewing.

At the end of 2021, retail investors also rushed to buy in, but then encountered a brutal bear market: When retail investors flocked to the market at the beginning of the year, the VIX index and the ratio of put options to call options were both at low levels; but by early January 2022, the three major stock indexes had already peaked, and the S&P 500 had fallen by 19% over the year.

Amanda Agati, CIO of PNC Asset Management Group, told The Wall Street Journal:

"The FOMO (fear of missing out) sentiment has become so strong that retail investors rushed in at the last moment, which was the final frenzy, just as the market was sliding from its peak."

What is worrying is not only the prosperity of the market. Rising borrowing costs could lead to an economic slowdown, stifle corporate credit, and make it more difficult for companies and households to obtain loans.

In the past year or so, interest rates on auto loans and mortgage loans have soared by about 3 percentage points. Federal Reserve data shows that credit card interest rates have risen from 16% to 22%.

Although inflation has eased, with June CPI falling to 3% compared to the previous month, it is still higher than the Federal Reserve's target of 2%. The Federal Reserve is concerned that Americans will become accustomed to high inflation, so it continues to issue hawkish warnings even as the economy slows down. If the tightening policy continues, the stock market frenzy will not last long.