In a turbulent economy, chips can be a safe haven. Year to date, the

Philadelphia Semiconductor Index

has risen about 44%, compared with the

Nasdaq's

near 9% drop. But these stocks are by no means immune to stormy weather. Since March 10, as the Nasdaq fell some 27%, the SOX had its own 22% drop.

Some of the chip stocks hurt the most were the ones investors had previously loved the most:

RF Micro Devices

(RFMD)

, which dominates the market for the power amplifiers needed in cell phones, fell 50% between March 10 and April 19;

Broadcom

(BRCM)

, which owns the market for cable modem chips, dropped 41%, and

PMC-Sierra

(PMCS)

, a leader in networking chips, fell 42%. Still, the stocks remained in positive territory year to date.

Investors aren't worried so much that anything is fundamentally wrong with the companies; all indications show strong demand for chips across the board. But investors have become increasingly nervous about the high valuations the stocks have commanded: Even after the falls, Broadcom trades at 302 times trailing earnings, PMC-Sierra trades at 204 times earnings, and RF Micro trades at 144 times trailing earnings.

Chips Sliding Away
After a big run-up, semiconductor stocks have dipped, following the Nasdaq.

The stock that held up the best during the market collapse was one that, this time last year, was about the most reviled in the chip sector:

Advanced Micro Devices

(AMD) - Get Report

. The company competes against

Intel

(INTC) - Get Report

in the PC chip market. While the rest of the sector was tanking, AMD rose 45% on news that its high-end

Athlon

chips were selling like gangbusters.

In the old days, chip investors didn't worry much about the larger economy. Semiconductor stocks were ruled by supply. Demand stayed fairly constant, and prices rose as supplies tightened when companies ran out of room in their manufacturing plants. Companies would frantically build more, supplies would rise, and prices collapse -- and so would the stocks.

In those days, chips went into one basic thing -- computers. Now, however, they are in just about everything: phones, cars, light switches, toys. And if there is an economic slowdown, consumers and companies might stop spending on these new products. The mere fear that that could happen could spur the makers of some products to stop ordering chips. That's what worries

SG Cowen

analyst Drew Peck. "The spigots would get turned off and orders would turn down to zero," he says.

We had a small taste of that scenario in the second half of 1998, he says, when the fear that economic problems in Asia would spread globally caused chip manufacturers to stop their building out of inventory -- they assumed, incorrectly it turned out, that orders would slow.

Still, many chip investors are holding fast to their stocks. As Mark Weiss, an analyst at

Amerindo Investment Advisors

sees it, it would take a prolonged and widespread economic downturn to affect companies that make chips for Internet infrastructure. That's because telephone and cable companies are rolling out digital subscriber lines and cable modem networks now, and these companies are well-funded and don't have to depend on continuing money flow from venture capitalists.

These companies are in a race for subscribers. They know, he says, that subscribers will be easier to get initially than to steal once a competitor has signed them on. In this race, telcos will continue their build-out of the Internet infrastructure regardless of drops in the market, Weiss adds, and that means a continuing need for the chips needed to run the networks. That means little risk and much reward for companies like Broadcom,

Applied Micro Circuits

(AMCC)

and PMC-Sierra. (Amerindo owns Broadcom, but not Applied Micro or PMC-Sierra.)

"Only if the markets really got hammered in a terrible way, then you might see some slowing," Weiss says.