Like wayward delinquents, tech companies have managed to win approval lately by not screwing up too much.

With expectations already dim, investors gave hardware and chip companies a big pat on the head -- since April 1 Intel ( INTC) is up 19% and the Philadelphia Stock Exchange Semiconductor Index (SOX) has risen 17% -- just for managing to deliver first-quarter earnings on target. This despite the fact that those numbers showed little growth. Software outfits have likewise enjoyed price spikes, even after a rash of earnings warnings for the quarter.

Looking forward, many on Wall Street say sentiment may have raced ahead of results and is beyond the outlooks for second-quarter hardware sellers. One worry is that an inventory correction may be looming that could make this quarter a repeat of last year, when the SOX dropped 36%.

There is some strength elsewhere in tech -- storage and some pockets of software, like security and business intelligence, which bucked the trend of weaker software earnings with solid growth.

"First-quarter earnings look pretty good. In my opinion, that's what drove this rally. But the sales and the sales outlook for hardware we think are not very good," says Jerome Dodson, manager of the $294 million ( PARNX) Parnassus fund, which at the end of March claimed a hefty 38% stake in hardware and 8% of assets in software.

Tech giant IBM ( IBM) managed to hoist first-quarter sales a mere 4% from last year (when adjusted for the dollar's fluctuation), even though its purchase of PwC helped boost services sales by 15%. Revenue stayed flat at Intel and slid 4% at Cisco ( CSCO).

Microsoft ( MSFT), a welcome exception, saw sales rise 8%. But it also delivered guidance below expectations for its upcoming fiscal year.

Dodson says he's "substantially reducing" his stake in tech, unsettled by the sharp stock price rises against a touchy economic backdrop. "In the longer term I'm positive on the American economy, but we keep losing jobs. Over the next six months I think we're in for rough sledding."

Signs of the tough environment: On the hardware side, sales at tech giant IBM were down 6% from the same quarter last year (again, adjusted for the dollar's fluctuation). Ingram ( IM), the world's biggest tech wholesaler and a favored litmus test for demand, startled analysts with a second-quarter forecast that puts sales 7% below last year's levels.

Hope Springs Eternal

Yet despite the glum state of affairs in hardware and diminished outlook from Microsoft, the guidance from the leading semi shops was somewhat better than expected. Texas Instruments ( TXN) managed to squeeze out impressive year-on-year sales growth of 20% in its first quarter, while guiding for sequential sales to grow 7% overall in the second quarter (with the chip business up around 4%). And Broadcom ( BRCM) stunned the Street by forecasting quarterly sales will jump 13%, much better than analysts were expecting.

Even Intel's second-quarter guidance cheered some on the Street who'd expected worse: The midpoint of its forecast suggests sales will grow 6% over last year's levels.

All that encouraging news from the semi side left some market watchers feeling suspicious. Fred Hickey, the vehemently bearish author of The High-Tech Strategist, argues there's a yawning disconnect between semi outfits guiding for growth and the lame demand in their end markets.

"PC sales at IBM were disappointing and sales came up short at H-P, Gateway and Sony," Hickey points out. "PDA shipments were down 21%, cell-phone sales were nothing to be excited about, and auto sales fell 10%."

Hickey's takeaway: There's an inventory buildup under way, and it's likely to get a lot worse with the impact of severe acute respiratory syndrome (SARS) sharply knocking down cell-phone and PC sales in China.

But rather than acknowledge the disparity, he says the market has seized on the apparent good news on the semi side and brushed off the bad from hardware, potentially setting the stage for a nasty correction like last year's. "A year ago in the same quarter, semis went wild and the end markets didn't. Then the correction came in Q2 and Q3," he says.

"We're probably most concerned about the question of inventories," agrees John Rohar of hedge fund EGM Capital. "We're worried demand from the semi companies has been a little more than one would anticipate, more than on the hardware side."

Software's War Stories

Meanwhile, on the software side, many execs would like to forget the first quarter ever happened. With IT spending still stagnant and the economy hurting, the onrush of war in late March put the kibosh on late-closing deals.

As a result, early April morphed into an ugly warnings season with company after company warning of misses. "It was shockingly bad for vendors who are dependent on large transactions and are positioned in markets that are mature," says First Albany analyst Mark Murphy.

PeopleSoft ( PSFT), for example, warned and then delivered a financial report that showed a dramatic skid in license revenue. Siebel Systems ( SEBL) was hurt even more -- license revenue for the embattled provider of customer relationship software dropped 54%. Oracle's quarter didn't look too bad at first glance, but it was clear that the numbers got a huge boost from the dollar's slide against the euro and other currencies.

With all that pain in the sector, you might think investors would run away. You'd be wrong. Since the beginning of the year, the Goldman Sachs software index of 46 companies is up 13%. (By comparison, the Nasdaq Composite was up 12%; the S%P was up 5%; and the Dow was up 2% for the same period.) Interestingly, Siebel is up 22% in that period, while PeopleSoft is down 14%. And Microsoft is down about 3% this year.

Avoiding a June Swoon

Why is software doing relatively well on the Street despite the troubles of the big enchiladas? While the big applications players struggled, smaller companies in subsectors that are not as mature had an easier time in the first quarter.

Security software and business intelligence software, used by companies to sift through corporate databases for information and reports needed to support operational decisions, are both expanding markets and both tend to rate high on IT wish lists.

Business Objects ( BOBJ) topped analysts' estimates (although net income was down year over year) and Cognos ( COGN) reported quarterly revenue growth of nearly 15% year over year. And with hackers and terrorists taking turns scaring people, analyst Katherine Egbert of C.E. Unterberg Towbin says the strength in the first quarter shows that security software continues to be a priority investment for most firms.

Both sectors are expected to have reasonably strong June quarters, but don't expect much of a turnaround in the overcrowded field of enterprise application integration.

Oracle, on the other hand, may be ready to make a comeback. One reason: Customers have worked through much of the excess database capacity they bought during the Internet bubble, says Brian Skiba of Deutsche Bank Securities, who believes database purchases could pick up in the back half of the calendar year. (Deutsche Bank has a banking relationship with Oracle.)

More broadly, Richard Williams of Summit Analytic Partners says, "It's too early to make real calls on the second quarter for most software companies. I won't believe anything I hear until June 15." That's because so many deals close late in the quarter. But Williams isn't shy about making his best guess: "I didn't see evidence of a recovery in the first quarter and I'm very cautious about the second." Williams and other bearish analysts think software stocks are still too rich given the longer-term outlook.

Still, there isn't much talk about an earnings collapse in the June quarter, which tends to be seasonally stronger than the first quarter. First Albany's Murphy says "even if the environment stays the same, companies are making license misses more manageable by controlling costs."

Many businesses added storage and backup capacity to cope with the enormous increase of data during the Internet bubble and to prepare for Y2K. But that was three years ago, and companies are starting to think about upgrading, says analyst Brion Tanous of Merriman Curhan Ford. That still-nascent upgrade cycle pushed the sector to "a decent" first quarter, along with the weak dollar that helped a number of companies. QLogic ( QLGC) stood out with revenue growth of 31%, and net income that topped expectations. But it expects sequential revenue growth of only 2% to 5%.

Other storage companies set equally modest expectations for the June quarter, projecting growth of just 1% to 5%.

A company to watch: Veritas ( VRTS), the only pure-play software company in the storage sector. Veritas dominates much of the market, but is being challenged by a technological advance that allows software to reside in switches in addition to servers. "The market is Veritas' to lose, but the door is opening to much stronger competition, Tanous said.