Solly strikes again.

For the second time in less than a week, Salomon Smith Barney shook a thin summertime stock market with a renegade negative call. Last Thursday, analyst Richard Gardner took apart the PC sector when he claimed to have evidence of rising channel inventories at Compaq Wednesday, semiconductor analyst Jonathan Joseph's downgrade of the semiconductor industry sent the Philadelphia Stock Exchange Semiconductor Index, or SOX, down a colossal 9.3%.

Joseph based his call on a number of distressing macroeconomic and industry-specific factors, including a peak in capital spending, rising inventories among semiconductor producers, decreasing lead times for customers and even some signs of softness in component prices. But the bottom line was that the favorable supply/demand dynamic in the semiconductor industry, which has been responsible for driving the SOX up more than 50% this year, is starting to turn.

"Though a slowdown in the group may take six to nine months, we see 'first-mover' evidence of a trend reversal," Joseph wrote. In addition to his sector call, Joseph downgraded four stocks: Advanced Micro Devices ( AMD - Get Report) and Silicon Storage Technology ( SSTI - Get Report), because of their large exposure to flash memory; Texas Instruments ( TXN - Get Report), for its exposure to cellular handsets; and National Semiconductor ( NSM), because of its exposure to both the cellular handset and commodity analog markets.

AMD sank 8 3/4, or 10%, to 75 1/2; Silicon Storage lost 15 1/16, or 15%, to 83 15/16; TI fell 5 1/4, or 7.6%, to 63 3/4; and National Semiconductor plummeted 8 1/8, or 14%, to 50.

'Nothing Call'?

Some jaws were dropping along with the stocks. But most pros were yawning over the meat of Joseph's note.

"It's a nothing call," says Bruce Lupatkin, porftolio manager at North Bay Technology Partners, which doesn't hold any of the names mentioned in the Solly report. "It has no teeth. What it basically said is that commodity semiconductors are still a cyclical business, and at some point this year the cycle will peak. And even though I have no data today to back that up, I'm just going to downgrade the stocks because I have nothing better to do."

Darn SOX
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Indeed, there's nothing fundamentally controversial about Joseph's thesis. Even the most bullish semiconductor analysts agree that the current uptrend in the markets for commodity semiconductors like DRAM and flash memory will ultimately turn. Flash is undergoing a particularly broad buildout, as manufacturers like Intel ( INTC - Get Report) and Fujitsu increase capacity to meet intense demand from manufacturers of various handheld appliances. Everyone agrees that sooner or later, flash production will reach levels sufficient to turn the current sellers' market in the buyers' favor.

Timing Is Everything

The difficulty is timing that point. Most analysts don't expect it to come as soon as Joseph does.

Mark Giudici, who tracks semiconductor prices and inventories for Dataquest, says that he doesn't see semiconductor component prices coming under any pressure for the next 12 to 18 months. "It takes that long to get a fab going, to get stuff rolling out the door," he says, using the industry shorthand for a fabrication plant.

"From what we're seeing, the current trend is expected to continue until next year," Giudici says. "2002 will be the day of reckoning."

Analysts were also picking bones with Joseph's account of things like decreasing lead times, high capacity utilization and moderating component prices. "I don't know where he's getting his macroeconomic data," says First Security Van Kasper analyst David Duley. "I don't agree with most of the stuff he's saying. If you look at the specific data points, they seem very vague. I think the equipment sector has a lot of legs left in it."

2002: A Chip Odyssey

In his note, Joseph admitted that "lead times are a hard number to gather," and that "probably the most important indicator is of industry anecdote." Anecdotal evidence was telling Joseph that lead times, which describe the interval between when a customer orders and receives a product, were starting to get smaller. Shrinking lead times suggest that inventories may be rising.

"Lead times are generally rising," admits Giudici. "Overall, inventory levels look like some safety stock is being put in place. Inventory is rising to the effect of maybe 25 days on hand, which is a bit higher than the 10-15 days held a year ago. But it's still less than one month's inventory on hand. So that should keep the financial people happy."

Time will tell on that account. Few semiconductor investors were smiling amid Wednesday's carnage. "It's affecting a lot of the stocks I cover in the semi equipment sector," says Duley. "So obviously, he's caused me a lot of pain."

That's the sort of tension that arises when sell-side analysts try to do the oft-invoked but seldom-practiced job of leading, rather than following, trends. "It's what every analyst wants to do," says Duley. "I just don't think six to nine months is the right time frame." Duley, in keeping with many of his colleagues, says he's "generally a middle-of-2002 kind of guy."

See you there.