The once red-hot semiconductor sector is slowing down, with one team of analysts cutting their chip stock estimates for the first time in three years.

In a recent research note, Morgan Stanley analyst Craig Hettenbach lowered his estimates for the chip sector in the fourth quarter and the year ahead. Hettenbach also reduced his price forecast for seven stocks including Qorvo Inc. (QRVO), Microchip Technology Inc. (MCHP), and TE Connectivity Ltd. (TEL).

"The Start of Inventory Correction" 

Chip stocks have underperformed the broader technology market this year. The Philadelphia Semiconductor Index (SOXX) is up 9.5% year-to-date (YTD), while the Nasdaq Composite Index's return over the same period falls more in line with the S&P 500 Index, which has grown 9.4%. 

Morgan Stanley views the deceleration of chip stocks returns as a sign of "the start of an inventory correction." 

Hettenbach's downbeat outlook reflects an increasingly bearish sentiment on the Street regarding chip players in recent weeks. The investment bank downgraded the sector earlier this year, followed by cautious reports from analysts at Raymond James, Goldman Sachs, and Stifel Nicolaus.

Since the end of August, the Philadelphia Semiconductor Index has fallen 2.2%, versus a 1.2% gain for the S&P 500. 

What's Next

“There has been a healthy debate about how much of the risks are priced in, suggesting the bar is in the process of being lowered,” reported Hettenbach. “That said, if estimates begin to come down like we expect, it will be difficult for stocks to work.”

Morgan Stanley recommends hiding out in names like Amphenol Corp. (APH) and Analog Devices Inc. (ADI), while steering clear of low-margin players such as Cypress Semiconductor Corp. (CY), On Semiconductor Corp. (ON) and Sensata Technologies Holding PLC (ST).