Now that the end-of-year rally looks pretty much like a done deal, is it time to starting worrying about the usual first-quarter slowdown in technology? Not really.

Demand for PCs and mobile handsets has been strong all year, and that pushed overall sales of semiconductors well beyond expected levels. The resulting low inventories in hard drives and semiconductors, as well as stronger-than-expected sales of enterprise storage products, along with other positive indicators, are convincing some analysts and investors that 2006 will get off to a strong start.

"At the beginning of 2005 we were concerned that high inventories would undermine pricing," says Shane Rau, who follows the chip market for IDC. At the time, Rau and his colleagues forecast that overall chip-industry revenue would decrease by about 1% over 2004. But strong sales likely will have swung the estimated loss of revenue to a year-over-year gain of 5% by the end of the month, he said.

Sales, of course, are just one part of the semiconductor equation. If the industry fails to manage its capacity correctly, it can create gluts that decimate margins, or shortages of product that can eat into market share, as Intel ( INTC) demonstrated this year .

"Chipmakers have been more disciplined about adding capacity than they have been in some time," says Graham Tanaka, principal of Tanaka Capital. Those companies have the healthy cash reserves to expand their factories, but have used their strength in a controlled fashion, he says.

Giving the industry more flexibility is the decreasing time it takes to order, produce and deliver semiconductor-manufacturing equipment. Cycle time has decreased from 18 months or two years to less than a year, says Tanaka, who notes that some chipmakers in Taiwan are running their factories at close to 100% of capacity.

His bottom line? "We're entering a seasonally weak period with high utilization; a strong first quarter is possible."

What's more, margins for technology vendors have yet to peak, says Jeff Kleintop, chief investment strategist for PNC Advisors. "My expectation is that we can get back to the 2000 margin peaks," he says, adding, "We're not all that far below them."

One big trend: Capital spending by telcos is up as they shift to IP-based (Internet) networks to keep up with cable companies and other rivals, a trend that could benefit Cisco ( CSCO) and other hardware suppliers, says Kleintop, who holds shares of Cisco, as does PNC.

Storing Up for Winter

Giving tech bulls more ammunition this week was a pair of announcements from hard-drive makers that they will report better-than expected fourth (calendar) quarters. Both Seagate ( STX) and Western Digital ( WDC) filed reports with the Securities and Exchange Commission saying they will outpace expectations , and that pricing (for a change) is stable in the cutthroat sector.

"Our channel checks suggest that inventory levels should trough over the next week or so and exit the December quarter at or below last quarter's levels of four weeks for Seagate and around five weeks for the industry," Goldman Sachs analyst Laura Conigliaro said in a note to clients. "It should at the very least prevent any major price drop in this segment heading into the seasonally slower first half of 2006."

More good storage-related news came Friday, when IDC said sales of external storage systems -- the big boxes where enterprises park their data -- grew a record 12.5% year over year to $3.9 billion in the third quarter of 2005, the highest growth recorded in the four-year life of the survey.

Not surprisingly, EMC ( EMC) maintained its lead in the sector with a market share of 20.3% and sales of $786 million. But both Hewlett-Packard ( HPQ) and IBM ( IBM) came on strong, with sales growth of 14.7% and 20.2%, respectively, while EMC grew by 7% year over year, IDC found.

"Both IBM and H-P have a broad range and they are beginning to execute better across the board," says IDC analyst Brad Nisbet.

Still, it's worth noting that what looks like sluggish growth on EMC's part really isn't, Nisbet said. That's because Dell ( DELL), whose sales grew by 33.5%, did so largely by reselling EMC's products. In fact, of Dell's $325 million in sales, $248 million, or 76%, was derived from reselling EMC products under a different label, according to IDC.

Bottom line: The sector and the top three leaders did surprisingly well in the quarter and are well positioned as they move into 2006. (Nisbet did not issue a prediction for future growth, however.)

Looking at technology more broadly, Loomis & Sayles analyst Rich Crable said: "Inventories across most of tech generally look in line to slightly below normal. However, I think the key remains holiday sell-through -- if the consumer doesn't continue to spend through the end of the year, then it would be logical to expect OEMs to refrain from aggressive inventory restocking.

"On the other hand, if we have a strong holiday sales season, that momentum could carry through into the first quarter of 2006 and offset the typical seasonality."

He may be bullish, but PNC's Kleintop warned investors to keep the end-of-year rally in perspective. "Even with this current stock market rally, 2005 has delivered below-average returns for all asset classes," he wrote.

"On a total return basis, the S&P 500 is up 6% year to date and the Lehman Aggregate Bond Index is up less than 2% so far."

If the Dow Jones Industrial Average hits the magic 11,000 level, it would still represent a gain of just 2% for the year, while the Nasdaq Composite is up only 4% year to date despite its impressive move off the October lows.

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