Greetings. I’d like to intro myself as the new editor of Cabot Sector Xpress Cannabis Advisor.
I am taking over for Tim Lutts, but definitely not replacing him. No one could replace Tim. He is an excellent market thinker and a great person. I’ve enjoyed interacting with him and learning from him during the handoff. He has graciously agreed to consult on the phone from time to time, as needed, going forward. So, we are still in good hands.
That said, I do bring some strengths of my own. You can check my bio for details, but, high level, I have been a stock market investment columnist in the U.S. since I finished a stint at Columbia Business School in the mid-1990s. I currently write an investment column for MarketWatch. Before Columbia, I covered business, economics and politics in Italy for the Economist Group for six years.
I worked in newsletters early in my journalism career, so I’ve had an interest in this segment of publishing for a while. By joining Cabot, I’ve come full circle in a sense. I look forward to working with the great team at Cabot, and learning from them.
I plan to try to do a lot the things that Tim did well, and change direction a little bit, as well.
Here’s what I’ll try to do that will be the same. Tim is great at timing exits near tops, and re-entries on weakness. This makes a lot of sense. I tend to be a buy-and-hold investor, but in a highly volatile and sentiment-driven group like cannabis, it’s key to book some profits in strength, and raise cash to redeploy in the inevitable pullback. Tim is also good as sifting through the cannabis sector chaos to narrow down a short list of the best quality names. I hope to try to do both of these as well as Tim.
Here are four things I will do that will be a little bit different. Tim used these tactics, but I may emphasize them a bit more than he did, and in slightly different ways.
In my market analysis, I rely heavily on insider buying to guide me on stocks and market trends. I’ve tracked insiders on a daily basis since 2000, and I’ve learned a fair amount about the patterns and qualities to look for to interpret the insider signal. Insiders can give you a great read on individual names, sector trends, and the overall market.
There’s not a lot of insider buying in cannabis stocks, but there is some in ancillary stocks, and this should help us. Plus, their buying trends can tell us when it makes sense to get more “risk on.” Cannabis is certainly a “risk-on” group.
A Broader Reach
Speaking of ancillary stocks, I plan to be a bit more innovative than most cannabis sector analysts to go beyond stock ideas like Scotts Miracle-Gro (SMG) and the cannabis-related real estate plays. For example, I follow the biotech sector pretty closely. It should be no surprise that the growing use of increasingly stronger strains has health implications. After all, virtually all approved medications have unwanted side effects. Why wouldn’t cannabis?
While maintaining a core pure-cannabis play portfolio, I will also likely introduce a biotech company or two developing therapies that treat the negative consequences of cannabis use among subsegments of the population. I’ve never seen cannabis sector commentators do this before, but I think it makes sense given how widespread cannabis usage has become. It’s hard to walk down the block in Manhattan for more than 15 minutes without noticing the distinct aroma, day or night.
I am decidedly contrarian, so I track broad investor sentiment to help me understand when it is time to do the opposite of the crowd. This is one of the best ways to make money in the market and cannabis, a sentiment-driven group. Of course, Tim considered sentiment. All of the time. But I’ll use the dozen or so broad investor sentiment indicators I track on a regular basis to try to know when it’s best to turn more bullish on a volatile group like cannabis, which is so heavily influenced by the “risk-on, risk-off” thinking of investors in general.
For example, right now investor sentiment is extremely negative, and cannabis stocks have been particularly hard hit, suggesting they are a buy. Here’s what I mean.
*The Investors Intelligence Bull/Bear ratio was recently at one, on its scale of one to five. The way I use this gauge, any reading of one or below is a near-certain buy signal because it tells us that investor sentiment is approaching an extreme.
*Likewise, the most recent American Association of Individual Investors (AAII) sentiment poll showed 18% bulls and 53% bears, for a negative 35-point spread. This gauge sends a contrarian buy signal when the spread is at negative 10 points or more for four weeks in a row. Last week was the third week in a row this indicator gave a negative 10-point-plus read. This week will definitely bring week four, given Tuesday’s sharp selling following the inflation report.
*Finally, a much “stingier” Bank of America Bull & Bear Indicator has fallen back to zero again, representing extreme bearish sentiment, a very bullish contrarian signal. This sentiment indicator is stingier in the sense that it is more hesitant to give buy signals.
The upshot here is that sentiment is so dark, it is a buy signal for the market, and particularly for a sentiment-driven “risk-on” group like cannabis. I think this is a good time to buy cannabis names on the basis of this contrarian buy signal, either for a trade on gains as sentiment improves and investors turn more “risk on,” or as a medium-term play on strong sales growth and progress on decriminalization in Europe and the U.S.
I spend a lot of time on macroeconomic analysis, which helps me understand when investor thinking may be wrong on important economic trends. I think this can be quite relevant to cannabis investing.
For example, investors panicked Tuesday because of the strong inflation print. Cannabis stocks were particularly weak because they are just like tech companies in that their expected profits are way in the distant future. This means their valuations decline when discount rates in net present value (NPV) models are driven higher by rising inflation. Higher discount rates reduce valuations in NPV models. Inflation pushes up the bond yields that determine discount rates. So, not surprisingly, our cannabis portfolio was down 5.5% Tuesday (in line with the major cannabis exchange traded funds), while the Nasdaq fell 5.16%, compared to a lower decline of 3.94% for the Dow Jones Industrial Average, which has a lower tech weighting than Nasdaq.
Conversely, cannabis stocks (and emerging tech companies) may see support as investors figure out they are overreacting to the inflation threat. Are they really overreacting? No one knows for sure, but I think so.
A look at what I’ll call the “upstream” inflation indicators shows continued sharp declines in commodity and energy prices. Spot crude prices are down 26% from their June peak, for example. Meanwhile, regional Federal Reserve Bank business surveys continue to show marked improvement in supply chains, shipping bottlenecks and order backlogs, which were all sources of high inflation.
Research from Goldman Sachs tells us that it takes two to six quarters for improvements in upstream indicators to bleed through to the headline inflation numbers that investors watch, like the CPI. In other words, barring sharp reversals in the upstream indicators (which I do not foresee), relief should be on the way on the inflation front. The sharp market declines Tuesday tell us investors do not believe it.
My view is supported by bond market trends. Bond market investors aren’t always right, but they are often better at thinking through inflation trends than investors in the stock market. Consider what’s happening with “breakeven rates.” Breakeven rates are bond market projections of future inflation. Analysts calculate them by comparing the yields on treasury bonds to yields on comparable-maturity TIPS, or treasury inflation-protected securities. Despite the strong inflation print Tuesday, one-year breakeven rates were at 2.22%. And breakeven rates for five- and 10-year maturities were at 2.58% and 2.43%. Those numbers are pretty close to the Fed’s 2% inflation target.
Key Potential Catalysts Ahead
Despite the incremental changes I plan for the Cabot SX Cannabis Advisor, there will of course be a lot of continuity. A market strategist I worked alongside at Money magazine years ago once explained to me that stock prices are typically influenced by three factors: company events, sector events, and overall market moves, one third each. This is a good guide and it applies to cannabis, except that I would bump sector events up to 50% or more. I’d also add that political and legislative developments are often the primary drivers of cannabis sector moves. Thus, I will continue to closely follow important issues like safe banking reform, and U.S. and foreign decriminalization.
Other key factors I’ll be watching near term include: progress on legalization in Europe which may come before the end of the year (with Germany taking the lead); crackdowns on illicit trade which would benefit legal growers and sellers; and how and when the current oversupply of cannabis eases.
Of course, the U.S. Congressional election outcomes in November could have a big impact on the cannabis group, as well. So the elections are worth following. I am no better than anyone else at predicting election outcomes. But I do know that the public betting markets often excel at predicting elections, so I’ll be watching the odds at my favorite gaming sites for guidance.