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SEPTEMBER 22, 2004
By Amy Tsao Wishful Thinking on Chips? Investors hungry for bargains could get a rude surprise if fourth-quarter results are weaker than expected For most of 2004, semiconductor stocks have been in free fall. From January to the end of August, the Philadelphia Semiconductor Index plunged 26%, while the Nasdaq Composite index barely budged. However, despite third-quarter earnings warnings from Intel (INTC ) and others across the sector, weakness in chip stocks has started to abate. Since early September, the group has climbed 8%. What gives? The reasons for the market's recent interest are twofold. For starters, with shares so far down, investors are scooping up bargains. "The sell-off has been a little sharper than anticipated," says Edward Hemmelgarn, founder, president, and chief investment officer of Cleveland-based Shaker Investments. Second, many expect that the worst may be over and that results for the group will be solid in the fourth quarter, typically the industry's strongest season. "That's what people are starting to make some bets on," says Hemmelgarn, whose firm is overweight in chips. CONSUMER WATCH. However, that fourth-quarter bonanza is far from a sure thing. Makers of consumer products that contain chips have been cautious in ordering, given the weakness of the past year. "It's not good to be overly bullish just because the stock prices have come down," cautions Standard & Poor's analyst Amrit Tewary. "I don't think there's a really positive catalyst for the stocks." Still, Tewary acknowledges feeling cautiously optimistic himself: "They shouldn't go down much more," he says. For now, he rates the sector neutral overall and recommends buying diversified names like Microchip Technology (MCHP ), Maxim Integrated Products (MXIM ), and Linear Technology (LLTC ). Much depends on consumer demand. Considering that interest rates are on the rise, fuel prices remain high, and job growth is still sluggish, shoppers could have less appetite for products powered by chips, such as cell phones, flat-panel TVs, laptops, and other electronic gadgets. "We see a seasonal upturn, but it won't be as robust as in past years," says Tewary. He worries that the inventory glut chipmakers have been talking about for much of the year could still take several more quarters to correct. CONSUMER WATCH. Whether or not consumers come through, the recent rally in semi stocks may be the result of investors hedging their bets. "Investors don't want to underperform if semis have a good [fourth] quarter," says Marty Shagrin, an analyst at Victory Capital Management. But although he remains worried that many stocks in the sector could see "another leg down," Shagrin recently added to his position in Intel and Texas Instruments (TI ). The latest rebound may not be much more than wishful thinking at this point. Until companies provide more positive signals that inventories are being worked through and 2005 demand is intact, it's hard to count on a sustained rally in chip stocks.  Tsao is a reporter for BusinessWeek Online in New York Edited by Beth Belton
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