Chips a Tenuous Source of Strength

Updated from 7:05 a.m. EDT

To the relief of aggrieved investors, semiconductor stocks have been enjoying a modest rally of late. Optimists hope the rebound means rumors of the chip cycle's death were somewhat exaggerated.

On Tuesday, the Philadelphia Stock Exchange Semiconductor Index rose 2.5%, its sixth consecutive up session. To be sure, the rally followed a period of pronounced weakness; from its intraday peak on Jan. 12 to its intraday low on May 3, the SOX fell 22.8%. (On Wednesday, however, the index was under pressure -- recently down 3.5% -- as specialty chipmakers such as Altera(ALTR Quote), Broadcom(BRCM Quote) and Xilinx(XLNX Quote) fell sharply in the wake of Cisco's(CSCO Quote) less-than-spectacular results and outlook.)

While small compared with the preceding losses, the recent minirally is encouraging the sector's bulls, who have been saying that the semiconductor cycle has not yet peaked.

"Historical data shows that the top was called prematurely," said Jeff Rottinghaus, an analyst and vice president at T. Rowe Price.

Historically, there is a strong correlation between revenue growth and share value in the sector that should translate into continued growth for at least another three or four months, Rottinghaus noted. "If share prices peaked in January, which was months ahead of the revenue peak, that would be unprecedented," he said.

Longtime "chipheads" have been comparing 2004 with 1994, a year in which strong growth led many analysts to call a top, only to see a rally that continued into 1995. "Are we nearing peak growth rates? Yes. But that doesn't mean we can't hold these [growth] rates for a while longer," said Dan Niles, chief executive of San Francisco-based Neuberger Berman Technology Management.

However, Niles cautioned that the market remains very nervous over the prospect of higher interest rates and will likely be choppy for some time, as evinced by Wednesday's early action. He recalled that the prospect of higher rates in 1994 depressed chip stocks, but when the Federal Reserve finally moved, the shares rallied.

Bill Gorman, vice president in the equity research department of Philadelphia-based PNC Advisors, believes that growth rates have peaked -- at somewhat more than 30%. But he said the semiconductor industry can grow 25% or more this year and 14% to 15% in 2005. (Last week, the Semiconductor Industry Association said it will soon hike its forecast for 2004 growth to over 20%.)

"We think the industry could be in a favorable supply-demand situation heading into 2005," Gorman said.

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