The swing from exuberance to panic can be a fast one for the solar sector. Another switch in sentiment happened this week when news came out that Italy was considering a cap on solar installations at 8 GW. Right now it's just in draft form, but it spooked investors nonetheless.

A few weeks ago, we warned that solar investors may have worn their rose-colored glasses a little too long, and this week the hammer fell. But before we panic, let's put this move into a little perspective.

Across the board, manufacturers have done a good job diversifying their customer base over the past two years. The industry's reliance on Germany is still high, but the expected impact of Italy has been built into many manufacturers' projections. Trina Solar (NYSE: TSL), which sold 22% of its panels in Italy last year, projected just 10% of its sales in the boot-shaped country in 2011. Yingli Green Energy (NYSE: YGE) has just 7.1% of its sales in Italy during 2010 and expects 10% to 12% there this year. A reduction in demand will hurt, but I wouldn't panic over it just yet.

There's also the fact that we don't have a final ruling in Italy yet. We've gone through scares like this in Germany, and we've seen the blow to solar is softened a bit before a final law passes. Time will tell if that happens in Italy, but writing the country off now is a bit premature.

The shock Italy gave us this week is another reason to stick with manufacturers that have project development divisions. First Solar (Nasdaq: FSLR) and SunPower (Nasdaq: SPWRA) lead that group and should be cushioned if the second half of the year is tougher than expected. Most Chinese manufacturers are still trying to integrate and grow their upstream operations and don't have nearly the downstream capability of these two powerhouses.

JinkoSolar continues solar's hot earnings streak
Chinese solar manufacturers continued to hit it out of the park this week when JinkoSolar (NYSE: JKS) announced outstanding results. Revenue was up 156.9% from last year to $267.7 million as the company shipped 162.6 MW of product. But the great results weren't constrained to the top line. Net income jumped 340% to $55.8 million or $2.36 per ADS. Not bad for a stock trading at $26.97 as I am writing.

We've seen strong earnings across the board in the fourth quarter with Yingli Green Energy and Trina Solar leading Chinese Manufacturers. LDK Solar (NYSE: LDK), who hasn't announced earnings yet, even increased estimates to give a little kick-start to the New Year. But concerns for the second half of the year are an overhang on the industry.

If demand falls in Italy and capacity expands faster than other markets come online, we could be in for a price war. That's one of the reasons stocks like JinkoSolar trade for just more than five times 2011 estimates, and the largest manufacturer Suntech Power (NYSE: STP) trades just below eight times 2011 estimates. Investors don't like uncertainty, and they definitely don't like falling margins.

What to do now
This isn't the first time solar stocks have gone from an investor favorite to the trash heap overnight, and it probably won't be the last. But outside of Italy the wind looks to be at the back of solar manufacturers. Oil prices are rising as uncertainty spreads in the Middle East. Political will in the U.S. hasn't changed enough to back solar domestically, but eventually it will.

I prefer power companies with big project development groups like First Solar and SunPower. But at today's low multiples, Chinese manufacturers are starting to look awfully tempting.

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Fool contributor Travis Hoium owns shares of First Solar and SunPower. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

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