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Orders for semiconductor manufacturing equipment were up sharply in April, exceeding last month’s order level by 16 per cent and growing 60.4 per cent compared with the previous year. This also marks an acceleration from the 40.2 per cent year/year growth rate seen in March.

We described earlier this week how the optimism of the CEO at one equipment manufacturer appeared at odds with macroeconomic data, and followed up with the story that leading chipmakers are poised for dramatic capacity boosts already. This is adding up to a difficult outlook for semiconductor stocks.

After semiconductor equipment is ordered, it takes a few months to install it. Once installed, semiconductor equipment increases the available capacity at chipmakers, thus increasing the supply of chips. Meanwhile, the end demand for chips is growing at a much slower rate - 7.3 per cent year/year in March, the latest month for which information is available.

Basic economics tells us that when supply is greater than demand prices will fall. The chart below tracks the year/year change in equipment orders (supply) minus the year/year change in chip sales (demand.) When the columns are higher than zero, supply is growing faster than demand. When they are below zero, demand is growing faster than supply.

Yr/Yr Change in Equipment Orders Less Yr/Yr Change in Chip Sales

Chip Stock April \'06

Since January 2006, potential supply has been outpacing demand. We say potential, because we are measuring the orders, which will take several months before becoming installed equipment. However, since the market is said to look ahead several months, we believe this is the correct comparison to make when considering an investment.

Furthermore, this chart does not show the acceleration in supply growth that we mentioned for April, since that month’s demand statistic is not yet available. Since the highest demand growth rate in the last year has been 8.6 per cent, it appears highly unlikely that demand will accelerate by the same 20 percentage points as supply, which means the imbalance likely got worse.

Source: Bad Outlook for Chip Stocks as Supply Continues to Outpace Demand (AMAT, AMD, INTC, SLAB, TSM)