For now, investors believe the story proffered by semiconductor-equipment bulls that the recent slowdown in orders is just a setback.

Seemingly defying reason, shares of major suppliers like

Novellus

(NVLS)

,

Lam Research

(LRCX) - Get Report

and

KLA-Tencor

(KLAC) - Get Report

have risen since each company guided revenue below analysts' estimates for the current quarter. The market sentiment suggests the sector may have bottomed out after taking a beating this summer.

But that doesn't mean it's time to dive headlong into the chip-equipment space yet, since it's doubtful all the downside is priced into the stocks.

While semiconductor manufacturers

Samsung

,

Intel

(INTC) - Get Report

and

Texas Instruments

(TXN) - Get Report

have all reaffirmed their capital spending plans for 2004, another leading equipment buyer,

STMicroelectronics

(STM) - Get Report

, cut its 2004 budget by 10% from its previous estimate and plans to cut spending by another 25% next year.

Many analysts think other chipmakers will follow suit, adapting their budgets to a period of slower growth. After an expected revenue jump of nearly 30% this year, the semiconductor industry is expected to eke out growth of only around 4% in 2005, according to the Semiconductor Industry Association trade group.

Yet for now, investors seem inclined to shrug off reasons for worry, with chip-equipment stocks acting remarkably resilient. After declining steadily throughout the year, the S&P Semiconductor Equipment Index hit a low of 357 in mid-August and then popped upward again. Since then, it's traded in a loose range between 360 and 405.

The price run-ups and increasing trading volumes and share-price gains have prompted a few skeptics to take a closer look at some chip-equipment names.

"We're at a critical inflection point on many of these stocks. Is it time to buy? Not yet," answered Robert Bacarella, the technically minded manager of the

(MSCEX)

Monetta Select Technology fund. He's currently underweight both chip equipment and semiconductors, but he admits he's begun to watch charts much more closely.

One encouraging bit of news: the S&P equipment index, after falling below its 50-day moving average in July, has recently started to catch up again, though it has stayed below the 200-day moving average line after breaking the barrier in April.

"We could have another leg down," acknowledged Bacarella. "But we're beginning to see increased interest in terms of volume and momentum" in selected stocks, he says, singling out especially auspicious patterns in KLA-Tencor. He owns the stock in one fund but has considered adding to his position.

Even chip-equipment bears agree that at least some of the bad news in the sector has been priced in -- just not enough, they argue. The rally suggests the market has factored in a mild inventory correction but assumes demand will pick up again sometime early next year, believes Kevin Vassily of Susquehanna Financial Group.

Vassily, on the other hand, thinks industry weakness will last longer than the couple of quarters most people seem to expect. If that's the case, it would be a mistake for investors to throw in their lot with the bulls now.

Assume for the sake of argument, Vassily suggested, that it takes another year for the industry to bottom. "That's a long period of time for investors to absorb the downside in hopes of capturing the upside," he said.

As proof for his caution, he points to signs that industry growth has tapped out. By his reckoning, the semiconductor market saw 33 months of improving year-over-year comparisons between the fall of 2001 and its peak in July 2004. Twenty-seven out of the 33 months saw outright growth (as opposed to declining contraction in growth).

"By my analysis, we had a long upturn leading up to July and typically with something that long and robust, the correction period is not usually short in duration," concluded Vassily.

But investors can certainly be forgiven for their confusion about which side to follow in the bull-bear debate, since semiconductor-equipment companies themselves are clearly at a loss about what the future holds. That's partly due to uncertainty about economic growth prospects.

Case in point: during the company's earnings call last week, Novellus Chief Executive Officer Rick Hill referred to a "continual deterioration in the market" and noted concerns about high oil prices and the potential for inflation to surface. Despite those worries, he said the industry didn't appear to be in a

long-term slowdown.

Yet the next day, Novellus announced a layoff. Though the company's director of investor relations declined to give details, saying more information would be available at the company's midquarter update in November, a note from Banc of America analyst Mark FitzGerald pegged the size of the staff reduction at 10%.

FitzGerald, a bear on the sector, has predicted industry bellwether

Applied Materials

(AMAT) - Get Report

could follow with another layoff as soon as November.

The takeaway for investors: Don't rule out a continued trading rally in put-upon equipment names, if for no other reason than investors seem willing to look past the downside.

But in the longer term, the likelihood of tighter chipmaker budgets doesn't bode well for the chip-equipment industry. Despite Novellus' terseness on the issue, it doesn't bode well that a major industry player has already entered downsizing mode.