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A Chipper Outlook for Semiconductors

By Sam Stovall The tide has turned in a big way for semiconductor stocks, the newest group to join the Industry Momentum portfolio -- the list of industries with top S&P Relative Strength rankings. After a 51.6% decline in 2002, the S&P Semiconductors index outperformed the broader market year to date through Aug. 29, climbing 71.2%, vs. a 15.4% increase for the S&P 1500. Because the S&P Semiconductors index is market-capitalization-weighted, its return is greatly skewed by the performance of Intel (INTC), the world's largest chip company.

S&P anticipates that most chip stocks will outperform the broader market in 2003, as industry fundamentals continue to improve, and more decisively in 2004 and 2005, based on our projection of an economic rebound and on creeping obsolescence of tech equipment bought in 1999 for Y2K compliance.

SMALLER AND SMALLER. In the view of analyst Thomas Smith, who covers the industry for S&P, earnings reports in July from bellwether chipmakers, including Intel and Texas Instruments (TXN), have been positive in tone, and companies are looking forward to at least a seasonal lift in sales in the second half of 2003. Intel has raised its revenue and gross-margin guidance for the third quarter. Key overseas supplier Taiwan Semiconductor (TSM) reported rising capacity-utilization trends at wafer-fabrication facilities.

Smith notes that despite near-term optimism, chipmakers remain reluctant to offer earnings guidance more than one quarter ahead. S&P thinks the current weak pricing environment for chips will endure through 2003, but believes pricing might improve by late 2004. Unit-sales volume continues to grow, as modern economies find more ways to use ever-smaller, more powerful semiconductors.

Over the next 12 months, S&P believes chipmakers that participate in the digital signal processing (DSP), analog, power-management, and other chip categories that serve industrial, automotive, and consumer end-markets -- as well as communication and computing end-markets -- have the best prospects. Over the next several years, S&P thinks wireless telecom and datacom markets look most attractive.

TOP PLAYS. Smith points out that the chip industry has historically been subject to intense boom-and-bust cycles, but since 1980, annual sales growth has averaged about 15% to 17%. As the industry matures, S&P believes cyclicality will continue, but the long-term growth rate is apt to decline toward about 10%. By 2005, S&P projects that worldwide semiconductor revenues will approach $204.4 billion -- the level reached at the high point of the 2000 cycle.

What are S&P's top plays in the semiconductor group? Smith has assigned S&P's highest investment ranking, 5 STARS (buy), to three marquee names: Intel, Texas Instruments, and Analog Devices (ADI). Smith also has a 5-STAR opinion on Vishay Intertechnology (VSH), a maker of passive components, such as capacitors, that also has a significant presence in semiconductors.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of Aug. 29, 2003.




Computer & Electronics Retail/Consumer Discretionary

Best Buy (BBY)


Computer Storage & Peripherals/Info. Tech.

Storage Technology (STK)


Constr., Farm Mach. & Heavy Trucks/Industrials

Caterpillar (CAT)


Consumer Electronics/Consumer Discretionary

Harman International (HAR)

Not Ranked


Genuine Parts (GPC)


Internet Retail/Info. Tech.

eBay (EBAY)


Internet Software & Services/Info. Tech.

Yahoo! (YHOO)


Office Electronics/Info. Tech.

Xerox (XRX)


Semiconductor Equipment/Info. Tech.



Semiconductors/Info. Tech.

Intel (INTC)


Wireless Telecom Svcs./Telecom Svcs.

Nextel (NXTL)


* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief investment strategist for Standard & Poor's

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