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Merrill Lynch (ML) has issued a bearish warning to holders of chip industry stocks: sell your shares or risk further declines in value.

"Semiconductor equities offer no upside from current levels,'' the investment bank told clients. "Stock prices have declined, but we believe that they have the potential to decline further."

It also cut its industry rating from 'overweight' to 'underweight'. Fab equipment manufacturers were downgraded from 'overweight' to 'neutral'.

Intel - which is due to release is Q2 figure today - was cut to 'neutral' from 'buy' - as were 23 other companies, with 53 downgraded by ML overall. The chip giant expects revenues to fall between $8bn and $8.2bn, with many analysts forecasting figures at the lower end of that scale.

ML believes that chip buyers - primarily PC OEMs - will reduce their spending through the rest of the year in a bid to keep inventories at low levels. With chip makers busily ramping production on the back of high demand through the first five or six months of 2004, a sudden downturn in purchasing could hit earnings hard, the bank believes.

Hence a drop in its forecast for 2005 growth from 16 per cent to six per cent.

"The risk for material downward adjustment in the financial outlook for the semiconductor business is higher now than at any point since 2002," ML's report to clients says.

ML's bearish viewpoint contrasts with that of the industry itself. Last month, the Semiconductor Industry Association (SIA) predicted record revenues for 2004. The organisation believes global chip sales will total $214bn this year - almost five per cent up on the $204bn recorded in 2000, the previous record year. The projected revenues are 28.6 per cent up on 2003's figure of $166.4bn, which was 18 per cent higher than 2002's.

And investment in new fabs reached its highest quarterly figure during Q2.

Like ML, however, the SIA expects growth to slow next year, to 4.2 per cent.

But while May was a very strong month for semiconductor sales, a variety of reports suggest that June revenues will be weak. That decline may lie at the heart of ML's concerns.

Its worries appear to be shared by investors. The US chip stock tracking Philadelphia Semiconductor Index has fallen 13 per cent this year. Institutional investors in particular appear to be reducing their technology holdings. ®

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