The lead chip index could surrender up to one-fifth of its value by this summer. So says Merrill Lynch in a note arguing that investors have gotten too giddy about semiconductor stocks.

In a research note, analyst Joe Osha says the benchmark Philadelphia Stock Exchange Semiconductor Index, also known as the SOX, could plunge to 270-280 during the summer. Osha reckons that at that level, stocks would be about fairly valued, based on their historical multiples and return on operating capital.

On Tuesday, the SOX closed at 355, off 1%.

In line with his skeptical take on valuations, Osha also cut his ratings from buy to neutral on ATI Technologies ( ATYT), Intersil ( ISIL), Maxim ( MXIM), Nvidia ( NVDA), and Semtech ( SMTC). Given that all the shares have lately outperformed the broader market by a decent margin, he doesn't see any upside in their prices.

At this point, Osha says he no longer has "buy" ratings on any semi stocks.

In the wake of first-quarter earnings, he and other analysts have pointed to a disparity in outlooks between semiconductor companies, which have generally been upbeat and guided for growth, and their hardware customers, which have lately sounded far more cautious. Among others, Fred Hickey of The High-Tech Strategist has argued chip stocks look vulnerable to an inventory correction.

But while Osha sees a big potential downside looming for the SOX, he doesn't expect the pain to be nearly as bad as at this time last year. Between March and September of 2002, the SOX lost 67% of its value as investors unhappily came to terms with last year's curtailed growth forecasts.

Osha points out that stocks now aren't nearly as expensive as then, with chip shares currently sporting average price-to-earnings ratios of 26 times 2004 earnings. In the spring of 2002, the group traded at around 42 times the next year's earnings.

Also, the SOX was above 600 in spring of 2002; now it hovers around 350, meaning there's likely less room to fall.