Time to Buy Oil Stocks

Oil stocks are oversold. On Oct. 5, I suggested that oil stocks were overbought and it was time to reduce exposure in this sector. As of Tuesday night, the Energy Select Sector SPDR (XLE - commentary - Cramer's Take) (an oil stock ETF) was down more than 10.8% since then.

Many indicators are now giving the green light to buy stocks. In the past, when oil stocks have become this oversold, it has led to an epic bottom within a couple days.

Let's start from the top by taking a look at the stock market. Many indicators are signaling that now is good time to buy stocks. One example is the reliably contrarian AAII survey, which is at levels of pessimism which can only be categorized as extreme.

Another indicator nearing bullish levels is the put/call ratio. The 21-day moving average of this indicator on Friday and Tuesday was at 1.06. When this indicator has reached these levels, the S&P 500 has generally bottomed within two weeks.

The S&P is trading 7.79% below its 21-trading day moving average. This is the 49th-lowest reading going back to 1950. The average return of the S&P 21 trading days after reaching this level is 3.58%. The last 16 readings have all produced at least a 4.21% return.

Drilling into the next level, let's look at oil stocks. The moving average convergence/divergence (MACD) of the XLE as of Tuesday is -1.814, which is the lowest reading in history. How have oil stocks behaved in the past when the MACD has been below -1.281?

• July 23-25, 2002. The XLE put in a low (an intraday low that has never been breached again) on July 24.
• Oct 21, 2005 (-1.281): The XLE put in a low on Oct. 20.
• Sept. 20-25, 2006: The XLE put in a low on Sept. 25.

So, in the past, when the MACD of the XLE goes below -1.281, it has always seen a bottom that has never been violated within five calendar days.

Another indicator that points to higher prices in oil stocks is the Down January Indicator. Here's what happens when oil stocks are experiencing a lousy January at some point in the month.

As you can see, a poor January for oil stocks is not unusual. In fact, XLE has been down more than 8% at some point in January most of the years of its existence. What makes this particularly striking is that oil stocks have done quite well this decade. Buying at the low in January when XLE is having "issues" has provided at least a 14% rally. This includes 2001, when the oil stock index finished down 19.5% for the year and 2002 when the XLE finished down 16.3% for the year.

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At the time of publication, Debevec had no positions in the stocks mentioned, although positions may change at any time.

James Debevec II is the portfolio manager of Absolute Value Fund, LLLP. Debevec is also a Chartered Financial Analyst Charterholder and a Chartered Market Technician. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Debevec appreciates your feedback; click here to send him an email.