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Don't Dismiss Chips Now

Editor's Note: This is a bonus story from Tom Kurlak, whose commentary usually appears only on RealMoney . This piece ran on RealMoney on the afternoon of July 12, but we're offering it today to readers. To read Tom's commentary in real time, please click here for information about a free trial to RealMoney.

Whatever happened to "buy low, sell high"? A lot of tech analysts seem to have gotten it reversed lately, running away from stocks already down 25% to 40% due to fears of an impending slowdown that doesn't seem to be evident in the reports I get from top industry participants.

Indeed, one leading chip-equipment maker, Novellus (NVLS), just reported a 41% increase in sales and a fivefold jump in profit, above analysts' views, but some were unimpressed, instead looking for a slowdown. Novellus' management raised its third-quarter guidance, calling for a 113% year-over-year sales gain, which is up 22% sequentially, in a summer quarter.

Fears of a peaking semiconductor cycle are largely based on the worry that too much new capacity is being installed, thus glutting the market. This looks wrong to me. As I said in my previous column , chip-equipment buying this year will total about $44 billion, or about 20% of semiconductor industry revenue, estimated by most forecasters to be around $225 billion.

This ratio of spending to sales is in line with the industry's 20-year long-term average and is only half of the level at the last cycle peak. Today, the CEO of Applied Materials (AMAT) commented on CNBC that his customers are planning to buy more equipment, are upbeat and need the newest equipment technology to meet rising demand. Also, recent data from the Semiconductor Industry Association show that capacity utilization is near 100%.

Meanwhile, the semiconductor companies aren't having an inventory buildup that is out of line with what is normal this time of year in anticipation of seasonally stronger second-half demand. That's especially true in Intel's (INTC - Get Report) case, where it has new microprocessors coming to market for new notebook PCs. A leading electronics distributor tells me his inventory is in good shape, and his customers are optimistic.

Up until today with Novellus, we've only gotten earnings statements from also-ran, third-tier semiconductor companies that confessed to be having trouble (meaning, losing share) and that see trouble ahead. Let's wait for the real players before forming a judgment on the industry. Wall Street downgrades into earnings releases imply that either some bad news is anticipated or analysts are trying to make their opinions fit the current climate.

I'm a proponent of anticipating change; it's what a good analyst tries to do. But I've never seen a major cycle peak out after only a year and a half. Sure, there have been a lot of mini-cycles within an overall recovery, but for longer-term investors, those have always been buying opportunities.

In the whole scheme of things, I don't see much chance for this economic recovery to top out, even with an administration change in the White House. Neither candidate wants this recovery to stall. The semiconductor industry grows by about five times the growth in real GDP; so as long as GDP exceeds 3%, this year and next should be good growth years for the chip companies.
At time of original publication, Kurlak was long Intel, Applied Materials and other tech holdings not mentioned in this column, although holdings can change at any time.

Tom Kurlak is an independent investor specializing in technology industry investments. He has more than two decades of experience as a senior Wall Street semiconductor analyst and technology hedge fund manager. Kurlak consistently ranked among the nation's top analysts in the annual Institutional Investor Magazine All Star Research Team survey. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Although he cannot answer questions about individual securities, Kurlak appreciates your feedback and invites you to send your comments to .

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