Figuring out which way the winds are blowing in the chip sector just got harder. Recent news suggests the all-encompassing rally off the September lows has ended and the sector's investors will have to be much more selective going forward.

In the past week, investors have applauded relatively upbeat reports from

Intel

(INTC) - Get Report

and

National Semiconductor

(NSM)

, which both delivered positive views of inventory buildups that have plagued the industry. Casting a shadow on those warm tidings were dour midquarter updates Wednesday evening from

Altera

(ALTR) - Get Report

and

Xilinx

(XLNX) - Get Report

, complete with lower sales targets.

Two conclusions can be reached from these seemingly conflicting events: First, it may take one more quarter to determine if a painful inventory correction is over. Second, making the correct bet on which companies have or haven't gotten beyond the inventory correction is crucial because the sector is now more of a stock-picker's market than before the Philadelphia Stock Exchange Semiconductor Index's impressive 22.7% run since Sept. 8.

"Semiconductor companies are being asked to hold inventory a lot longer," said Alan Loewenstein, co-portfolio manager of the John Hancock Technology Fund. "The question going forward is will the business pick up so that the inventory comes down?"

National Semi CEO Brian Halla said Thursday that he believes the sector is in a

"slow, steady climb-out" of the inventory buildup. The company projected sales in the current quarter would be flat to slightly down following an 18% sequential decline in the quarter ended in November.

But less than 24 hours earlier, both Altera and Xilinx painted a gloomier picture in their midquarter updates. Both stocks took a beating Thursday as they lowered respective December-quarter sales targets and each said total inventories will rise. Altera said total inventories will rise to about four months' supply on hand, up from prior guidance of 3.3 months to 3.7 months. Xilinx reported inventory both at the company and distributors will increase to 170 days from prior guidance of 156 days.

The bifurcated views of chip inventories presented this week may not be as different as they initially appear; National Semi just ratcheted down its sales targets about a month earlier than Altera and Xilinx, said Doug Freedman, an analyst with American Technology Research. On Nov. 1, the company said fiscal second-quarter sales would

decline nearly twice as much as previously thought.

In fact, no one else in the industry has suffered as big a sequential drop compared to peak levels as National Semi, Freedman said, estimating the company's sales ultimately will sink nearly 25% from peak levels.

The analyst believes investors bid shares of National Semi up on Thursday because the company maintained its margins relatively well, whereas in the past, the company's bottom line would have started bleeding red under such a dramatic sales drop. (Freedman has a buy rating on National and does not cover Altera and Xilinx; his firm doesn't do investment banking.)

What's more, National isn't the first company to foresee an end to the inventory buildup, Freedman said. Even as it issued first-quarter sales short of analyst estimates a few weeks ago,

Analog Devices

(ADI) - Get Report

said that it believes much of the inventory buildup is likely to be

absorbed by the end of the first quarter.

Analog chip makers typically are less sensitive to inventory buildups because their devices have longer shelf lives than those made by digital chip makers like Xilinx and Altera, Freedman noted.

"Their inventory is at risk, while the inventory at Analog or National is not at risk and holds its value more over time," he said, noting that the average sales price of analog devices may drop 3% to 5% year over year while digital devices suffer a 25%-to-30% drop. Still, their end-markets overlap, with National providing power management products for Xilinx and Altera products, for instance, Freedman said.

Still, First Albany analyst Auguste Richard suggested in a note Thursday that the market for programmable logic devices, or PLDs, where Xilinx and Altera play is recovering more slowly than other segments of the semiconductor industry.

"This is not surprising as the PC supply chain is a single mature market, whereas the end market for PLDs, is far more fragmented," wrote Richard, who projected a flattish March quarter for Xilinx and Altera and revenue growth resuming in the June quarter. (Richard has buy ratings on Altera and Xilinx, and his firm hasn't done banking with either company.)

Loewenstein, meanwhile, has avoided Altera, Xilinx and National Semi because he believes they still are at risk of missing future targets.

"If you believe that the economy is going to grow, you do want to own the semiconductor stocks," added Loewenstein, whose fund holds Intel. "However, you have to look at it on a six-month time frame -- rather than week to week -- because if they don't get orders, they won't make numbers."

Loewenstein said the fund may pick up those names if they deliver another weak quarter, but it looks like the economy is picking up. That would indicate that their fundamentals should be turning positive.

"It will take another quarter to sort through what's going on," he said.