Is the sky falling in on the chip market? With chip giants Intel and Advanced Micro Devices (AMD) preparing to report earnings early this week, industry pundits are divided over whether or not a slowdown in the chip market is looming. Yes, the sky is falling, Salomon Brothers analyst Jonathan Joseph said two weeks ago, kicking off the debate by releasing a report predicting a slowdown coupled with potential supply glut. Stocks predictably fell. However, other industry and Wall Street analysts shouted the report down. So who's right? The semiconductor market is notorious for its boom-and-bust nature. Putting new manufacturing capacity into place is like rolling dice. Due to their complexity, chip makers must begin building new manufacturing plants, known as fabs, up to two years in advance of forecasted demand. Forecasting that far into the future is notoriously difficult and inaccurate. Intel, for instance, would have avoided its current shortage of high-end chips by starting the ball rolling on new capacity in 1998. Instead, the company held back adding capacity, and it's paying for it now, analysts said. That's because, "from everything we've seen, demand is still hot and heavy for flash memory and microprocessors. Neither Intel nor AMD can keep up right now," says Mike Feibus, principal analyst at market research firm Mercury Research. "We're rarely at equilibrium in the microprocessor industry," Feibus says. "You just can't accurately predict how much capacity you're going to need in two years." Upon further review, however, Joseph's report may not be off the mark. The report basically cites early signs of a slowdown, including slight slowdowns in cellular phone growth and a marked increase in capital spending. With additional manufacturing capacity coming online and with lower demand, it's likely an oversupply state and a market slowdown will occur. Joseph's report predicts a slowdown could begin in six to nine months, with a major hit to the industry coming in 2002. Is an oversupply is likely to occur? "I think it's kind of a no-brainer," Dan Hutcheson, president of VLSI Research, which tracks the semiconductor manufacturing equipment market, says. "But why discount (the market) today? The (oversupply) is two years out." Two years' time, however, gives a lot of leeway for things to change. A lot of things could change over the next two years, but one thing is a given. Semiconductor companies such as Intel are spending billions of dollars to boost capacity. Intel alone has boosted its 2000 capital spending estimates to $6bn from $4bn in just a few months, its largest effort to expand capacity since the mid-90s, analysts say. Meanwhile, according to reports from Reuters, semiconductor makers in Japan have boosted capital spending to record levels. Reuters reported recently that three of Japan's top five chip manufacturers have, in recent months, raised projections for capital spending to a combined $8.45bn. This surpasses the previous high of $8.19bn, spent in the 1995-1996 business year. Joseph and Hutcheson argue this capacity spending will, eventually, lead to oversupply. Using a mix of macroeconomic and microeconomic indicators, Joseph builds his case that the chip sector is going to encounter a few speed bumps. He cites growth rates and capital spending, as well as lead times, pricing and inventories. History is on Joseph's side. The semiconductor industry has habitually misjudged demand, as there is no magic method of matching capital spending with demand projections. Chip makers continually follow a boom-and-bust cycle, boosting capacity in good times only to be weighed down by excess inventory and falling prices in the bad times. "We believe strongly that semiconductor cycles are mostly defined by excess capacity rather than a fall-off in demand, particularly in the economic boom of the 1990s," Joseph wrote. Joseph also pointed out that capital spending peaks coincide with industry spikes. The current spike is about to lead to a valley, he says. The years of peak capital spending -- 1984, 1988, 1995 and 1997 -- coincided with peak shipments and oversupply soon after. Industry group Semi reckons equipment shipments are up 75 percent in the first six months of 2000. Meanwhile, semiconductor shipments peaked with a 34 percent increase in February and fell to 30 percent in May, said Joseph in his report. The real clincher for Joseph is inventory data. "Despite reports of rampant component shortages and supply shortages, inventories somehow have begun to build both within semiconductor companies, and, to a limited degree, selected customers," wrote Joseph. Joseph's report had an immediate impact. It hit several semiconductor companies hard. Specifically, Joseph downgraded Texas Instruments, AMD, National Semiconductor and SST. However, it wasn't hard for ZDNet to find analysts to disagree with Joseph, with most saying it is too early to predict a slowdown two years out. One such analyst, Carl Johnson, president of Infrastructure, a semiconductor industry research firm, describes the report as a "macroeconomic gut call sprinkled with fairy dust". Johnson does give the report credit for pointing out risks to the semiconductor industry. However, he says, all the doom and gloom cited in it "doesn't deter the longer term outlook". Johnson, instead, believes the semiconductor industry is in the early part of a 12-to-18-month growth cycle. "In six to nine months we could have a slowdown, but based on today's evidence, that's not the case," Johnson says. Could the semiconductor industry have entered a new, more resilient, age? During previous downturns, the PC chip market, which represented 40 percent of total chip shipments, dominated the industry, says Johnson. "Now the chip sector is diversified from the PC era." The rise of the Internet, wireless communications and other new markets has boosted demand for semiconductors on the whole. As a result, Johnson argues, the industry is now much more diversified and, therefore, more resilient to downturn. The industry is less likely to be affected by a downturn in a single market, such as flash memory. The only exception would be an economic downturn, which could cut demand for semiconductors. These facts make 2000 and 2002 dramatically different from 1997 and 1998, when chip makers boosted capacity only to produce too many chips. Piper Jaffray analyst Ashok Kumar agrees. In a recent research note, he said Intel's capacity spending spree has little to do with PC chips. Kumar said Intel is targeting cell phones, handheld devices and networking chips as the next frontier. "We expect most of the new capacity will be used for non-PC devices," said Kumar. "We've heard Intel talk about new markets, but so far, they haven't contributed much to the bottom line. But this capacity build-up implies big plans for future growth." Officials at Intel and at AMD declined to comment for this story, each citing an earnings "quiet period" as the primary reason. Intel reports its second-quarter earnings on Tuesday. Analysts predict it will meet First Call estimates of 99 cents a share. Excluding one-time gains, Intel is expected to report earnings of about 72 cents a share. AMD will report its second-quarter earnings on Wednesday. Analysts expect the company to show a profit of $1.14 a share. Wall Street has raised expectations following two consecutive blowout quarters from AMD. Intel won't stay mum for long. Its second half outlook is expected to be a major topic of discussion on its earnings conference call. See to Chips Central for daily hardware news, including an interactive timeline of AMD and Intel's new product launches through Q1 2001. See ZDII for US tech investor news. See techTrader for more technology investment news, plus quotes and research. What do you think? Tell the Mailroom. And read what others have said.