Consumer Woes Hit Chip Stocks

A downturn in semi stocks has dovetailed with a slump in retail.
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Microchips and sweaters have little in common, but both are equally unfashionable on Wall Street these days.

The semiconductor and retail sectors have been beaten down by investors, each hewing to a strikingly similar and consistent downward slope despite all the recent volatility that has rocked the market.

What's on the Horizon for Semiconductors

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The pattern reveals anxiety about the direction of the U.S. economy, but it also testifies to an evolving semiconductor sector in which new forces increasingly determine the fortunes of chip stocks.

Since the beginning of September, the Philadelphia Stock Exchange Semiconductor Sector Index is down roughly 17%. The S&P Retail Index (RLX) has lost about down 12% in that time frame.

That's considerably worse than the

Nasdaq Composite

and

Dow Jones Industrial Average

, which are each down only about 1% in the same period.

"Anything related to the consumer has been a tough space to be in the last three or four months," says Becker Capital Management's Pat Becker Jr. "There's a perception that, with $90-some oil and a housing recession, the consumer has to slow down."

A pause in consumer spending is bad news for the chip industry. More than 50% of chip revenue now comes from products purchased by individual consumers, according to the Semiconductor Industry Association -- a big change from past years when corporate and government spending provided the bulk of the sector revenue.

And chips aren't merely inside the latest tech gadgets, notes Becker. Semiconductors also are wired into washing machines and automobiles. Those kinds of discretionary consumer goods have been "an area of strength of the past several years, and we think you're going to see some slowing there," he says.

Investors will get an update on sales trends Wednesday when

Altera

(ALTR) - Get Report

and

Xilinx

(XLNX) - Get Report

provide midquarter updates (although both chipmakers are less exposed to the consumer sector than many of their peers), and then on Monday, when

Texas Instruments

(TXN) - Get Report

, the leading maker of cell-phone chips, delivers a business update.

With holiday sales season now in full swing, the Street is hungry for any new nuggets of information.

Still, as important as fourth-quarter retail sales are to chipmakers, not everyone is convinced that chip stocks are suffering the same fundamental problems that have pounded traditional discretionary stocks like retail.

For one, consumer electronics products such as personal navigation devices and flat-panel TVs have been big sellers in recent months -- and in the initial days of the holiday sales season, according to early reports. Consumers may not be buying new home furnishings, but they don't appear to have stopped lusting for iPods yet.

Dan Niles, CEO of Neuberger Berman Technology Management, points out that the performance of the 18-stock SOX index isn't the best gauge of the overall chip sector, given that 38% of it is weighted toward memory and capital-equipment companies, such as

KLA-Tencor

(KLAC) - Get Report

,

Applied Materials

(AMAT) - Get Report

and

Micron

(MU) - Get Report

.

Neuberger Berman Technology Management owns shares of KLA and Applied Materials.

Memory chips are currently in abundance, punishing both memory firms and chip-equipment makers. Viewed from that perspective, the latest slump in the chip index doesn't look so different from its last two troughs -- in 2004 and 2006 -- when the culprit wasn't the U.S. economy but the traditional chip bugaboo: an inventory glut.

Unlike some past chip downturns though, the pain isn't being felt broadly across the chip sector this time around.

"For the last several years, you've had to really work through the

chip companies name by name, because the industry is more mature now," says Niles.

At the moment, say investors, there are pockets of strength and weakness throughout the chip industry. The trick is finding stocks that have been inappropriately lumped in with the losers, whether because of generalizations about slackening consumer confidence or inaccurate notions about business spending on information technology.

With so many chip firms trading near 52-week lows -- including

Broadcom

,

Spansion

(SPSN)

and

Fairchild Semiconductor

-- stock-pickers have plenty of broken stocks to sift through.

And with the bearish macroeconomic outlook currently in effect, any improvement could lift all boats.

"If the U.S. does not slip into a recession, then semiconductor stocks could be poised for a rebound, given low valuations,

the healthy global demand picture and constrained supply growth across the broader market," says Friedman Billings Ramsey analyst Craig Berger.