Living Dangerously In Solar Stocks

When it comes to the stock market, bottom fishing can be a dangerous game.

Once momentum takes hold, particularly downward momentum, it can continue well past the point where logic is the defining factor. Despite that, though, it was what I was trained to do. Life in a dealing room is about seeking opportunity and taking risk in a controlled manner and there is no denying that when prices are falling there is opportunity. The rewards for a contrarian trade are such that, providing you can cut for a relatively small loss if things don't pan out, it is worth taking a shot, or even repeated shots, at finding the bottom.

In general, in order to have a logical level at which to set a stop loss to limit the downside to such trades, however, you have to wait for at least a small bounce before jumping in. That way, by setting a stop to protect against a renewed push downwards, you can participate in any sustained recovery without risking too much. That, in turn, enables you to try several times to find the bottom of a sustained move. It is not a strategy for the faint of heart, nor for somebody whose emotions can get the better of them. Taking losses, even small ones, is no fun.

With that in mind, for those not opposed to taking a risk, the required "drop and bounce" pattern is present right now in the solar power sector. It is probably best demonstrated by an ETF for the industry in general, such as the Guggenheim Solar Fund (TAN).

As you can see, solar has not been a good place to be over the last year. After a lag, stocks in the industry started to follow oil on its downward trend, and the move was exaggerated by China's problems and their government's response to them. China is a huge manufacturer of solar cells and panels, and the general overcapacity in their manufacturing sector and slowing growth in their economy translates to oversupply in the industry in general. What the chart indicates, however, is that we may finally have found a bottom on August 24th, when TAN traded at the low of $24.51.

I would stress the word "may" in the above sentence, as the famous "dead cat bounce" is always a possibility. The fact is, though, that despite the possibility of problems in the future, the majority of companies in the fund are profitable and growing, so a trailing P/E of just over 10 for the fund as a whole looks to have a lot of oversupply priced in at this point.

The fact that the fund is international, with over 38 percent of holdings being Chinese has no doubt contributed to its rapid decline, but to some extent that gives protection against possible problems faced by North American and European companies in the industry. The devaluation of the Chinese currency, along with the country's proclivity for subsidizing exports could create problems for solar companies outside the country in the near future, but those subsidies will get the Chinese companies through the worst. It should be noted that in many ways, none of these problems are new to American and other Western companies anyway, yet most of them are cash flow positive. This morning, First Solar (FSLR) issued a somewhat bullish guidance for the second half of 2015, indicating that industry insiders believe that the problems are not likely to be as bad as feared and that the worst is already over.

There are, therefore, reasons to believe that TAN could bounce quite seriously from here. That combined with the proximity to that recently formed low, creates an opportunity to buy below $30 with a stop at just below that low, say at $25, giving a downside of around 15 percent. That is not ideal, but should be manageable if only a small portion of investable capital is deployed, and there is significant upside if the bounce is real.

As I said, this is not a trade for the risk averse, but if you are investing in an active style, then you have to accept risk, and even embrace it at times. Now looks like one of those times.