My bet is on the glass half-full. I have been carefully watching the trading action in the two sectors for which I do primary coverage - semiconductors and solars - and it was notable that semiconductors barely budged to the downside during Friday's record drubbing.  The widely-read Investors Business Daily recently ran an article on the strength in semiconductors, Are Semiconductors Set To Lead Market?, by Trang Ho (June 6, 2008).

Some highlights from the article:

Chips sales worldwide rose 5.9% year over year to $21.2 billion in April....Sales in the first four months of 2008 ticked up 4.3% over the same period in 2007 to $82.9 billion. Lower prices resulted in a 14% drop in revenue for memory products, even though the number of units sold increased. Excluding this category, chip sales climbed 12% year over year in April. The SIA projects sales of the two largest drivers of chip demand — PCs and handsets — to rise 10% and 12%, respectively. Growth in these two end markets come mainly from outside the U.S.

"Chip stocks are early cycle movers that typically lead the Nasdaq, both up and down," said Richard Romey, president of ETF Portfolio Solutions.

The S&P Semiconductor index fell 36% from its July high of 57.39 to a low of 36.71. It bottomed toward the end of March and has since risen above its 10-week and 40-week moving averages. It's now trading 17% below its high with heavy accumulation.

Chip companies are reporting earnings surprises to the upside:

ON Semiconductor, (ONNN) gapped up 20% in monster volume May 7 as earnings pleasantly surprised.  The company said Thursday it expects Q2 revenue of $545 million to $560 million. That includes 2% to 6% organic growth and about $150 million in revenue from the buyout of AMIS Holdings. Analysts polled by Thomson Reuters forecast revenue of $552.6 million, up 45% year over year.

National Semiconductor, (NSM) beat profit forecasts Thursday. Q4 earnings climbed 21% year over year to 34 cents a share on $462 million in revenue. Analysts expected it to earn 26 cents a share. It guided Q1 sales above views.

Broadcom, (BRCM) launched a Bluetooth chip set last week. The company claims that the chip is smaller and enhances sound quality while using less energy. The company has beat earnings estimates the past two quarters.

I first began encouraging investors to take a serious look at semiconductors in late October, 2007 (KLIC - A Silicon Canary Begins to Chirp), and followed that up with articles in January, 2008 (Shakespeare on Semiconductors: sail with the tide) then February 6, 2008 (FormFactor - Down so low it looks like up to me), March 18th, (Kulicke and Soffa's New Bonder Line) and lastly, on April 8th, (Building a KLIC Pyramid) in which I detailed the trading strategy I would utilize.  Since that time, Kulicke & Soffa (KLIC) is up 50%, FormFactor (FORM) is up 25%. Most of what I have to say is included in these articles

The DRAM index clearly shows an upswing beginning in mid-December, 2007. The DXI index uses an easy to understand graphical representation of the semiconductor industry's DRAM market trend. As the Dram Exchange explains,

The index is calculated by multiplying mainstream DRAM chips with their respective street price. The DXI index not only reflects the output value of the DRAM industry, it also depicts the stock price changes of DRAM makers. Therefore, the index provides users with an accurate account of the highly volatile memory business and a strong correlation with the spot price.

So where do we go from here? I think we're at the halfway point, and any pullbacks from here will provide investors with a second opportunity to grasp the meat of the cycle. I have positions in KLIC (target $14), followed by FORM (>$35), Novellus (NVLS) (>$30), Lam Research (LRCX) (> $55), Micron (MU) (>$14), Marvell (MRVL) (>$25), Maxim (MXIM) ($35), AMD (AMD) (>$15-20), and the lowly Qimonda (QI) (>$8).

The Solar Sector

The solar sector is a long story within a brief time frame, but the heart of the story lies in a tremendous growth story book-ended by fear and exhilaration, or what I liken to the "push me pull you effect" of market-driven journalism coupled with sensational speculation. When the stocks are being "pushed" by analysts, upgrades, and a favorable atmosphere on the Nasdaq, you want to own them. But you must first buy them when "everything's wrong with 'em" (like right now).

Last week there was the German scare that that country's solar subsidies would be drastically cut (they were cut, but just minimally, and now the rate is considered permanent). In January and February, 2008 there was the fear that the Spanish solar subsidy would be cut (it wasn't appreciably); and that the U.S. would not extend its solar tax credit after 2008 (the jury is still out on this one, but it looks likely that a long-term U.S. solar subsidy - similar to California's - will be passed by summer). The triple-digit upswings and 50% downswings of the solar sector have made for volatile trading, but the fundamentals of the companies - and the VC investment in solar in general - continues to strengthen. At their March 2008 lows some of the best known Chinese solar stocks had single-digit forward P/Es combined with record profits and revenues. A tremendous value. Many of them doubled aftewards in April.

If the U.S. congress announces a significant extension of the solar tax credit later this year, we could be off to the races again. My sense is that the largest economy in the world - the one most-favored by geography for sunlight - wants to go green with a vengeance. If that proves correct, billions ($) in investment capital will be chasing a handful of publicly-traded U.S. solar companies.

Disclosure: I currently have a long position in the solar companies Akeena (AKNS), Trina Solar (TSL), Suntech Power (STP); and Ying-Li Green Energy (YGE)

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John Gilluly

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