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SAN FRANCISCO -- Investors seem to be losing faith with semiconductor stocks these days -- a sector that was a favorite for tech investors last year. On Wednesday, the Philadelphia Semiconductor Index, or SOX, fell 67.37 to 1193.80, a level that erases all the gains made in the index since March 3.

Some stocks have taken a prolonged beating.



, a maker of analog chips for wireless devices, is now at its Feb. 1 level; network chipmaker

Applied Micro Circuits


has fallen back to its closing price of Feb. 10; and equipment maker

PRI Automation

(INTC) - Get Intel Corporation Report

is back where it traded Dec. 21.

Even such chip stalwarts as




Texas Instruments

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(TXN) - Get Texas Instruments Incorporated Report

have suffered from the selloff, which seems to go beyond just profit-taking.

All of these stocks, like the rest of the chip sector, had been on consistently upward paths.

Analysts who follow these companies say investors are being nervous Nellies, because business is still good. This is a sector, they remind us, that typically shows ample warning flags of an impending crash, and none of those flags are waving.

The chip market is one of supply and demand. Demand almost always rises, but prices fall when supplies are plentiful, a condition that grows out of excess manufacturing capacity. There is a shortage of manufacturing capability right now, and the situation likely will persist for at least another year, says

Montgomery Securities

analyst Brett Hodess.

According to analysts, these are the conditions that principally drive the chip industry, and neither is signaling problems:

Warning Sign #1: Book-to-Bill

Chip investors watch the equipment sector as an early indicator of the health of the industry. Well before there is too much manufacturing capacity, which means a collapse of chip pricing, chipmakers cut down on equipment purchasing. When orders for equipment are strong, the industry is healthy.

In February, the industry received 1.4 new orders for every order shipped. That matched the previous high, set in February 1995. Compare that with October 1998, when the market bottomed, with only 0.73 new orders coming in for every order shipped. Analysts don't start biting their nails until the ratio nears 1.

Warning Sign #2: Overspending

Preceding the last chip crash, which hit in 1997, there was a frenzy of spending by memory makers such as

Micron Technology

(MU) - Get Micron Technology Inc. Report


Hyundai Semiconductor

. While they expect to spend about $3.8 billion this year on equipment, memory makers still have catching up to do after several years of frugality.

"I don't think spending is outrageous yet," says Gerry Fleming, an analyst at investment bank

Tucker Anthony

. "The memory industry has definitely underspent for several years." Memory makers tend to cut equipment spending when memory sales are low, and beef up spending when the money pours in. Sales of memory chips are expected to soar through 2003.

So why are investors nervous? One cloud hanging over the industry, Fleming says, is a new

Securities and Exchange Commission

accounting rule that will force equipment companies to recognize revenue only after buyers formally accept the equipment, a process that can take months. Currently, most companies recognize most of the revenue when the product is shipped, because returns of this complex equipment are almost unheard of.

Some investors may be worried, Fleming says, that a restatement of revenues to reflect the rule change will make earnings hard to predict for the next few quarters. "This market is so earnings surprise-driven," he says. "People can get really upset if a company misses its numbers."

Hodess says other things have shaken investors as well: Recent political turmoil over elections in Taiwan, where the bulk of chip manufacturing occurs, and worries about inflation and interest-rate hikes.

Overall, institutional investors have been telling him that while they feel confident the chip industry will remain healthy for the near future, they are becoming more cautious about the second half of the year and beyond.

So what will restore confidence? Fleming says investors already have bought into chip stocks on expectations of a booming second quarter. Now they are waiting to hear, in upcoming earnings announcements, that the third quarter will be a doozy as well.