It's Clear Skies Ahead for the Chips

09/01/2010 10:39 am EST

Focus: MARKETS

Michael Murphy

Former Editor, New World Investor

Michael Murphy, editor of New World Investor Radar Report, says bearish Wall Street analysts are ignoring the good news on semiconductors and technology.

The chips are semiconductors, and the dips are the Wall Street analysts [who] follow the industry, all of whom make day traders look like serious investors. It’s not an easy industry to follow—I have been doing it for over 40 years—and things can change quickly.

On the other hand, when you are paid to be first to see a change, it isn’t surprising that the dips have called seven of the last three downturns. They are at it again.

First, the real numbers. The Semiconductor Industry Association [recently] reported that worldwide chip sales for the first half of 2010 hit $144.6 billion, over 50% higher than a year ago. They predicted that 2010 sales would hit $304 billion, about 28% more than the $238 billion sold in 2009.

The market research firm IC Insights expects 2010 global chip sales to be $310 billion, the biggest jump in annual sales in the industry’s history. Another market research firm, iSuppli, said that “this will be the longest period of consecutive quarterly growth since the industry grew by 19 straight quarters between 1991 and 1995.”

One of the biggest reasons for all this good news is that there are shortages everywhere, so prices are not declining at nearly the normal rate. There is a strong pent-up demand for technology products, with business capital spending up more that 21% year over year.

At the same time, global consumers are lining up for mobile Internet devices like smart phones and tablets, and high-speed connections.

So, who doesn’t get it? “We are seeing several signs of softening demand for technology products across the globe,” JP Morgan analyst Christopher Danely warned his clients in a [recent research] note. “We believe the semiconductor sector is exhibiting the classic first signs of a correction.”

The “classic first signs” he is referring to are increasing inventories at the chip suppliers. But guess what? Since the unforgettable semiconductor inventory recession of 2001-2002, customers and manufacturers have changed the way they do business. The customers want the inventory to stay on the manufacturers’ books, even if it is sitting in a locked cage on the floor of the customer’s facility.

And the real reason inventory is up is the shortage of capacity. Companies order 30 different chips to make a product, and then discover one of them is out of stock and can’t be scheduled for production for a couple of weeks. That leaves quantities of 29 other chips in inventory, while they wait for the 30th chips to arrive so they can build the product.

Semiconductor analysts on Wall Street make their money by scanning the horizon for the next black cloud, and being first to call the downturn. Unfortunately, that almost always means several of them cry wolf before a real downturn emerges. Demand is not declining anywhere, and the inventory overhang will be taken care of by getting the needed chips, building the products, and quickly selling them—especially with the holiday build coming up.

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