Earlier this week, in Cabot Cannabis Investor I suggested buying cannabis stocks on a pullback – but only if they went below my suggested buy limit.
The stocks fell below that limit, and they are now up 10%.
That’s a nice gain in just a few days.
But more importantly, there are a few key takeaways for everyone in this profitable trade.
2 Takeaways on Buying Cannabis Stocks on a Pullback
1. Cannabis stocks are extremely volatile, so it’s key to have discipline on entry points and examine what’s behind rallies to know when you shouldn’t trust them.
For example, the early 2024 cannabis stock rally was suspect because it was sparked by non-news. It was triggered by the publication of a letter from the Drug Enforcement Agency (DEA) to a representative in Congress. The letter merely mentioned the DEA is reviewing a proposed rescheduling of cannabis to Schedule III from Schedule I under the Controlled Substances Act.
Of course, this was not news at all since we already knew this. The key here was to understand this was not news, to avoid chasing the rally and instead wait for the inevitable pullback. We did, and we got a better entry that led to the quick 10% gains.
2. Cannabis stock weakness is buyable below the right buy limits because there is enormous political and cultural momentum supporting the normalization of cannabis laws. Understanding this is also key because that makes it easier to buy cannabis names when they weaken – creating the inevitable fear, uncertainty and doubt, aka FUD, that happens when stocks decline.
We see evidence of this cultural momentum in opinion polls, continued state legalization of recreational use, record sales in states that legalize rec use, and the elimination of cannabis from drug test lists in sports leagues – most recently the Ultimate Fighting Championship (UFC) – among other trends.
This political and cultural momentum confirms my expectations of several key catalysts ahead. Here are a few to watch for.
1. More details on rescheduling. We learned January 11 that the Department of Health and Human Services (HHS) will soon release its full rescheduling recommendation. The documents will be publicized in response to a Freedom of Information Act request from attorney Matt Zorn at the law firm Yetter Coleman. These documents may reveal important information about rescheduling – chiefly the medical evidence HHS cites in arguing cannabis should be rescheduled. That will tell us how compelling their case for rescheduling is.
The history here is that in October 2022 President Joe Biden told various administrative agencies to reform federal cannabis laws. Last summer HHS sent the DEA a letter suggesting cannabis should move to Schedule III from Schedule I.
This change would be big news for the cannabis group. It would boost cash flow at cannabis companies by allowing them to deduct operating expenses on federal tax forms. Currently, an IRS rule called 280E prohibits this. This provision’s application to cannabis would be voided by a move to Schedule III.
2. A proposed rescheduling rule. The next step in rescheduling will be the publication of a proposed rule by the DEA. The problem for investors here is that the timing is unclear.
One cannabis regulatory expert, attorney Howard Sklamberg who is a partner at Arnold & Porter, thinks full rescheduling (not just DEA publication of a rescheduling rule) will happen by the summer. That would give Biden plenty of time to tout the victory for campaign purposes. Sklamberg is worth listening to because he was the chair of the Food and Drug Administration’s Marijuana Working Group for several years.
However, another cannabis regulatory expert I talk with, Shane Pennington who is a partner in the law firm Porter Wright Morris & Arthur, is skeptical of this fast timeline scenario. He notes that rescheduling typically takes a long time, as many as nine years.
Who is right? We don’t know. But recent cannabis referendum results in Ohio offer a clue. Voters in Ohio, a state that leans right politically, recently approved a referendum legalizing recreational use. This outcome was not obvious because conservatives are less likely to favor cannabis legalization.
The fact that Ohio approved the change offers a key lesson to politicians of all stripes – that supporting legalization may be a good way to attract votes. “The datapoint is important for all the candidates thinking about how they get the votes they need to be successful,” Cresco Labs (CRLBF) CEO Charlie Bachtell said this week in an AdvisorShares podcast called AlphaNooner. “It wasn’t a legislative initiative. It was the people speaking and the turnout was strong.”
Translation: President Biden should understand from Ohio that getting rescheduling done by this summer could be an important part of his election campaign.
All of this is a quick glimpse of some of the complex array of moving parts in the cannabis space. For example, the feds won’t be the only government providing cannabis sector catalysts in 2024. At least three states will make substantial progress on legalization this year, including two big ones that will move the needle on sales. For more on the timing of these and other catalysts, details on the best cannabis stocks to own, and suggested entry prices for the best returns, consider subscribing to Cabot Cannabis Investor.