You'd never guess the semiconductor industry was in recovery mode, given the gloom pervading the sector. Despite signs of firming demand for chips, Wall Street analysts have lately busied themselves

hatcheting their profit estimates for companies in the group.

Many who had expected the industry to follow its usual boom-bust cycle are at last admitting there's nothing typical about this rebound. Though some hold out limited hope for a better-than-expected second half, they're officially junking visions of a V-shaped recovery. (Something like this is happening in the software sector, too; to see a story on it,

click here .)

Distortions in chip demand "caused by the extreme depth of the '01 downturn have made conventional wisdom ineffective for investors," acknowledged Bear Stearns analyst Charles Boucher in a research note Tuesday in which he dropped revenue and earnings estimates on 11 chip stocks.

Meanwhile, Merrill Lynch cut its projections for capital spending growth in 2003 from 30% to as low as 20%, a rate that implies sequential growth only in the low single digits for chip-equipment makers through next year. "This would be the weakest upturn on record if those rates occur," wrote analyst Brett Hodess in a note downgrading 13 chip-equipment stocks.

The Difference This Time

Though chips are a famously volatile industry, this time around the peaks and valleys have been even steeper than usual. Following a wild spending binge from 1998 to 2000, demand fell off a cliff: In 2001, sales of semiconductor devices dropped nearly 45%, with chip-equipment sales, in turn, declining around 35%.

More recently, demand has finally started to pick up, with unit volumes of chips expected to grow about 19% this year. "Growth rates are pretty much along the trend lines," said Bill McClean, president of Scottsdale, Ariz.-based IC Insights, a market research firm.

Conventional thinking -- and economic logic -- would dictate that when demand increases, companies can raise the prices of their goods.

But this time around, chipmakers haven't been able to do that. The problem -- an unwelcome legacy of the boom years -- is that there are still more than enough semiconductors to go around, and that has effectively put a ceiling on chip prices. In fact, back in May heavyweight

Intel

(INTC) - Get Report

instituted steep price cuts on its lineup of Pentium 4 processors.

"Overcapacity in the industry leads to low selling prices," said McClean. His firm expects average selling prices for chips to be down about 13% this year, resulting in dollar volume growth of only 5% for the industry.

He predicts the industry will see growth rates typical of a recovery, around 20% to 30%, in 2003 and 2004.

The current situation, while unusual, isn't entirely unprecedented. From August 1996 to August 1997, chipmakers staged a short-lived rebound even as selling prices contracted, noted a research report from Thomas Weisel Partners. But when chip prices stalled out, the industry wasn't able to sustain the recovery. It finally succumbed to a steep downturn at the end of that period.

"If the pattern seen in 1996-1997 repeats itself, we could see an early end to this cycle," said analyst Kevin Vassily.

For that matter, even when the recovery gains traction, not everyone is convinced sales in the related equipment industry can return to their prior levels. "Over the course of the nascent upturn, which we project to last through early 2004, we believe that sales of semiconductor equipment should fall short of levels in the last upturn," said Wells Fargo analyst Susan Crossley in a May industry overview. "If so, this will be the first cycle in industry history in which peak revenue levels do not exceed the prior peak."

The strength of IT spending through 2000 "sets the stage for tough cycle-to-cycle comparisons," she said.

The near-certainty of a bumbling, unsteady recovery will probably weigh on chip stocks through the summer.