This morning before the open Birinyi Associates issued a research report on the energy sector and several reasons for today's rally.
1) After yesterday's decline most energy stocks were the most oversold they have been in the last 18 months. Several of these stocks have reached such levels in the current decline, but a mass sell-off in a sector to extreme lows is usually a good indication of a bounce.
2) The average bear market for the energy sector is about -31%, the current decline was about -28%.
3) Using shares outstanding for the DIG (2x long energy ETF) and DUG (2x short energy ETF) funds we are able to identify buying in energy names.
Below we will break down each of the points listed above. First, the energy sector as a whole traded down to a new theoretical low (more oversold than any other period in previous 18 months). This is the first indication that a stock or group is outside of its normal trading parameters.
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Secondly, this bear market in energy has taken the sector down nearly as much as the historical average for these stocks.
More importantly we believe, were the stocks which were nearly all at extreme oversold levels. (Please click to enlarge.)
Additionally, this does not appear to be a short-term trend. Prior to the decline in energy we saw a large increase in shares outstanding for the DUG fund that coincided with increasing volume. Now we are beginning to see that trend reversing. Holders of DUG are selling shares back to the issuer, and we are seeing an increase in the shares outstanding for DIG which coincides with increasing volume.
(We attribute the difference in scale for shares to two things: Difference in price DIG: $65 vs DUG $40, and long only accounts using DUG as a hedge where DIG might be less useful as they can just buy stock.) Based on the table highlighting historic bear markets for energy it is possible that the decline may continue (the worst was -47%), but at this point there is a good case for consolidation and a trading opportunity as the sector returns to its normal range.