A week before computer giants

Hewlett-Packard

(HPQ) - Get Report

and

Dell

(DELL) - Get Report

report earnings, there are signs of life in the near-moribund server market.

But buy-siders, usually quick to leap in ahead of recoveries, remain skeptical about the industry's investment potential. And as long as server titans keep knocking each other over the head in Three Stooges-like fashion as they fight for market share, fund managers seem likely to keep their distance.

Their indifference comes despite signs of potential improvements in the long-troubled market. Monday, a sales executive for server and storage maker

Sun Microsystems

(SUNW) - Get Report

told

Reuters

about indications of a rebound in business from telecom and financial services, both major server customers. Investors bid up Sun shares 11% in a day on the news, pushing the stock to $4.39.

The Sun comment follows last week's government report that estimated

third-quarter corporate spending on overall computers and equipment leaped 15.4% from year-earlier levels, up from 8.3% growth in the prior quarter.

The upbeat GDP news has prompted speculation that big companies are starting to open their wallets, which would add to the strength in consumer buying that has lately spurred PC and chip sales.

Nonetheless, fund managers seem inclined to sit out any server rebound. "I wouldn't invest in anticipation of

a rebound in the server market, because I don't know how we're going to get it. Customers are pretty smart these days in bidding out servers. And when they bid these things out,

IBM

(IBM) - Get Report

, Dell and H-P just kill each other over pricing," says one buy-sider. "You're going to see that from Dell and H-P next week."

Price competition was partly to blame for IBM's disappointing third-quarter gross margins, and it could weigh on Dell and H-P's upcoming results. "During the quarter, H-P and IBM likely stepped up the competition in industry standard servers, which should put

Dell's pricing down year over year," predicts UBS Warburg analyst Benjamin Reitzes in a Tuesday note.

Likewise, Sun and H-P have lately engaged in a flurry of dealmaking in a bid to win over each other's customers, culminating in H-P's October offer to

award $25,000 worth of services to Sun customers who defect.

Besides persistent price pressure, another factor hurting server sales is that customers don't have a compelling technological reason to buy new hardware. Among high-end

Intel

(INTC) - Get Report

four- and eight-way servers, increases in processing power have outpaced corresponding increases in memory, and that means users can't tap into the full processing gains. "You're not able to get any real performance boost, because we haven't seen the pickup in the next generation of memory chips to come along. They're limited by memory and bus speed," says the buy-sider.

He's been playing the recovery by plunking money into component suppliers such as

Maxim

(MXIM) - Get Report

,

Linear Technology

(LLTC)

and

Micron

(MU) - Get Report

. "If there's a pickup in servers, these guys will feel it. If there isn't, they'll still benefit," he says.

At the Tanaka Growth fund, Graham Tanaka says he thinks corporate spending increases may not materialize until sometime in 2004. The GDP results were "a very positive sign, and I think it could presage the beginning of a recovery in IT spending," he says, noting that IBM said it expects customers to increase IT spending in 2004. "But you still have in the back of mind of many corporate managements questions about whether the recovery is for real or just one or two temporary spikes due to tax cuts."

He's been buying up chips, semiconductor equipment and software companies rather than hardware, on the premise that those investment areas offer higher profit margins and more stable growth than server-related plays. Tanaka has stakes in Intel,

Novellus

(NVLS)

,

KLA-Tencor

(KLAC) - Get Report

and

ASM International

(ASMI)

; he also owns

Business Objects

(BOBJ)

and

Symantec

(SYMC) - Get Report

. On the hardware side, his only holding is Dell, which he likes for its share-gain prowess.

Turnaround Timing

Just recently, in what counts as progress for servers, the business stopped deteriorating. After nine straight quarters of shrinking revenue, server sales quit declining in the second quarter of 2003, eking out a 0.2% increase from last year's levels to $10.6 billion. The quarterly result came in slightly above IDC's forecast for a 1.7% slide.

"It's too early to declare an absolute turnaround," said IDC's Jean Bozman. "The only way to tell if we're in a rebound is several quarters of quarter-on-quarter growth in revenues as well as units." But she adds, "There certainly are positive signs out there."

Bozman says an IT turnaround is typically foreshadowed by rising chip sales and growth in contract manufacturing. The first has already happened.

Third-quarter chip sales jumped nearly 18% from last year's levels, the strongest percentage increase since 1990, according to the Semiconductor Industry Association, a trade group.

But contract manufacturing -- the actual fabrication of goods like servers and PCs -- remains relatively weak. At RBC Capital Markets, analyst Keith Dunne says the sector reported sales that were about 1.5% better than third-quarter consensus expectations, but revenue remains about 1% below last year's levels.

So evidence of rising demand is still fragmentary. But more to the point, no one expects a resurgence in purchasing to be enough to stem the near-constant price battles. And unless that happens, investors are likely to shy away from server rebound plays.