Cannabis stocks are getting sold down as if the industry has no future.
This makes no sense, but there is a good explanation. Traders and investors bought the group heavily on expectations that cannabis sector banking reform would be passed in Congress by year’s end. The AdvisorShares Pure U.S. Cannabis (MSOS) exchange-traded fund (ETF) saw five to ten times normal volume on four days in early December, following two months of accumulation.
When the banking reform did not make it into a defense spending bill – as was anticipated – a lot of hot-money traders had to exit. They pushed cannabis stocks and ETFs way below where they traded all year. This created more negativity, which created more selling.
I put funds into the group in anticipation of SAFE banking reform. It would have been irresponsible not to. Sources were putting the odds of approval at 75%. If the bill had gone through it would have been a game changer for cannabis stocks. That would have sent them much higher, even beyond their peaks earlier in the month.
SAFE banking reform, formally called the Secure and Fair Enforcement Act, would give cannabis companies access to banking services including the use of credit cards for purchases. This would improve funding capabilities and move dispensaries away from being all-cash businesses. Psychologically it would legitimize the industry to a large degree.
There’s actually still a chance the SAFE banking act could pass this year, say sector analysts based in Washington, D.C. At this point that would be a huge surprise, but it is not out of the question (see below).
Otherwise, the same favorable trends that have been at work have not gone away.
The bottom line: For long-term investors, the cannabis group looks like a solid buy here, given how much the stocks have been hit. Several medium-term trends remain quite bullish, yet the stocks are being decimated by disappointed traders who had bet on help from politicians in Washington, D.C.
Here are five reasons I like the group in this pullback.
1) Insider buying is bullish. During December 7-9, a director at our Cronos Group (CRON) continued to buy large amounts of his company’s stock. He purchased $1.2 million worth at around 2.89 on average. This followed $2.1 million worth of purchases from November 8 through December 6 in the 2.90 range. That brings the total to $3.3 million at 2.89 to 2.96 during November and December, so far. This is a very large buy for a relatively small company like this, which makes it a compelling signal, both for the stock and for the group, in my opinion.
2) SAFE banking reform could still get approved this year. It may still get attached to an omnibus federal spending bill. Cowen’s Washington research team says the House and Senate are close to releasing an omnibus spending bill early next week. They think Senate majority leader Chuck Schumer (D-NY) might be able to get SAFE banking provisions into the spending plan. “We continue to expect SAFE to pass,” says Cowen, though the brokerage acknowledges its crunch time.
“SAFE is not dead yet,” agrees Cantor Fitzgerald analyst Pablo Zuanic, citing widespread support among politicians. He thinks more than 60 senators support SAFE banking. Previous iterations of the bill were co-sponsored by 42 senators including nine Republicans. “How often do bills get that many Senate co-sponsors? Rarely.” The SAFE Banking Act has also passed in the Democratic-controlled House several times.
The problem is that Senate minority leader Mitch McConnell (R-KY), who blocked the inclusion of cannabis banking reform in the defense bill, appeared to signal he’d keep it out of federal government spending legislation as well. Schumer, Sen. Cory Booker (D-NJ) and other cannabis reform advocates want to get the bill through during the lame-duck session while Democrats still controlled Congress.
If SAFE banking isn’t approved this year, there’s still a chance the cannabis group could see bullish news out of Washington, D.C. next year, AdvisorShares CEO Noah Hamman told me earlier this week. (AdvisorShares runs the AdvisorShares Pure U.S. Cannabis ETF.) The banking provision might still pass in 2023, given the bipartisan support it has had. According to a PEW Research Center poll in October, 59% of U.S. adults say cannabis should be legal for medical and recreational use, and only 10% say it should not be legal at all.
Otherwise, U.S. Attorney General Merrick Garland could issue a memorandum telling banks in states where marijuana is legal that they won’t be prosecuted for collaborating with cannabis companies. There’s precedent for this. In 2013 Deputy Attorney General James Cole issued a memo stating the Justice Department would not enforce federal cannabis prohibition in states that legalized marijuana. (The policy was rescinded in 2018.)
3) The cannabis market will continue to expand, regardless of what politicians in Washington, D.C. do. New York is rolling out dispensary regulations and legal sales will start soon. This will be a huge market. Connecticut and Rhode Island will start legal sales of recreational cannabis soon. Maryland and Montana are now working on the legalization of recreational sales. “At some point the growth should matter,” says Hamman, at AdvisorShares.
4) Europe is on the cusp of major reform. Germany is taking the lead. It’s finalizing proposed legislation that will legalize sales of cannabis for recreational use. That may set off a domino effect in Europe, say analysts.
Continued reform in the U.S. and Europe supports very bullish cannabis sales projections. “The legal U.S. cannabis market size is expected to triple by 2030, reaching an estimated $75 billion in annual sales,” says Trulieve Cannabis (TCNNF) CEO Kim Rivers. Her growth forecast doesn’t even include market expansion, as more states and Europe legalize recreational use sales. The research firm Headset projects 13% growth next year.
5) Grim market sentiment may soon improve, which would help a speculative group like cannabis. Investors are in a bad mood because of concerns that the Fed will create a hard-landing recession as it raises interest rates to fight inflation. Consider these gauges showing extremely negative sentiment.
The recent 30-day moving average of the Chicago Board Options Exchange equity put/call ratio, at .82, is as high as it was during the depths of the 2020 pandemic selloff. It is nearly as high as during the Great Financial Crisis, points out Charles Schwab chief investment strategist Liz Ann Sonders. That’s pretty grim.
A sell-side sentiment indicator tracked by Bank of America (measuring Wall Street strategist stock allocations) shows Wall Street has gotten so depressed in its outlook the negativity has created a buy signal, in the contrarian sense. The indicator suggests a 15% S&P 500 return over the next 12 months, taking it to 4,700. Historically, when the sell-side indicator was at current levels or lower, subsequent twelve-month S&P 500 returns were positive 95% of the time vs. 82% over the full history for the index, and the median twelve-month return was 21%. “Wall Street’s consensus equity allocation has been a reliable contrarian indicator over time,” says Bank of America. “In other words, it has been a bullish signal when Wall Street strategists were extremely bearish, and vice versa.”
Here’s what might change the gloomy sentiment. Inflation is coming down hard, suggesting the Fed may soon ease up. We saw signs of this in the Consumer Price Index data earlier this week. But the trend has been in place for a while. The three-month rolling averages of many of the key inflation components have pulled back so far, they’re showing that prices are now rising by 3%-4%, points out Ed Yardeni of Yardeni Research. Because of how fast inflation is coming down, he thinks the Fed can stop hiking rates early next year. This would ease worries about a Fed-induced hard landing. Historically when inflation spikes, it goes down as fast as it goes up. There is a symmetry to it. History does not always repeat, but this symmetry suggests a faster resolution of inflation than the consensus expects.
