Is a Liquidity Crunch in the Solar Sector Ahead?

Stocks in the solar and alternative energy space are getting crushed. Will it lead to a liquidity crunch?

Since the beginning of the year, the Guggenheim Solar ETF (NYSEARCA:TAN) has lost a stunning 21.80% in value compared to a +0.20% gain for the SPDR S&P 500 ETF (NYSEARCA:SPY). And while a 21.8% loss is most certainly ugly, many individual stocks within the solar sector are getting slaughtered.

Widely held solar stocks like SolarCity (NASDAQ:SCTY), and SunEdision (NYSE:SUNE) are down 55.85% and 81.92% respectively. Others like First Solar (NasdaqGS:FSLR) have lost 17.29% while SunPower (NasdaqGS:SPWR) is down 32.99%. All of these stocks are among the top 10 holdings in the $262 million Guggenheim Solar ETF.

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Most solar stocks are reporting large earnings per share (EPS) losses.

For third-quarter earnings, SunEdison reported a $284 million loss compared to a $283 million loss from a year earlier. That prompted its stock to sink further and the company is slashing up to 15% of its workforce and scaling back its growth plans by 20%, according to reports. The Maryland Heights, MO-based company is the globe’s largest developer of renewable-energy.

Meanwhile, SUNE holders are getting burned, literally. Top institutional owners of SUNE include David Einhorn’s Greenlight Capital, Daniel Loeb’s Third Point, and Vanguard. Hedge fund managers like Einhorn and Loeb are having their worst collective performance since 2011.

Like SunEdison, SolarCity has negative earnings and missed its third quarter EPS of -2.41 by 46 cents. SolarCity, which is headquartered in San Mateo, CA, designs, installs, and leases its solar power systems.

Other alternative energy ETFs that own solar shares like the Market Vectors Global Alt Energy ETF (NYSEARCA:GEX) and PowerShares WilderHill Clean Energy ETF (NYSEARCA:PBW) have dropped more than 20% over the past six months.

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Negative earnings coupled with crashing stock prices plus changing risk appetite by investors will lead to an inevitable shakeout in the overcrowded solar marketplace. And the liquidity crunch has already started.

In the meantime, prudent investors should add these questions to their due diligence checklist before diving in:

When will the risk appetite for financing the aggressive growth plans of money-losing solar projects wane?
When will institutional investors with significant losses finally bail and what further impact will it have on already beaten up share prices?
How will a recession or credit crunch impact the ability of solar companies to operate?
How much will existing shareholders be diluted when solar companies decide to sell more shares to raise capital?
With cheap natural gas prices, will utilities increase competition with solar by lowering electricity rates?

Sector ETFs that invest in solar stocks, if you decide to hold them, always go into a person’s non-core investment portfolio, whereas a person’s core portfolio is always diversified across the five major asset classes via ETFs that are accurate proxies of each category.

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