The dizzying price appreciation of cannabis stocks during the first two months of 2019 had to end sometime. After all 60-plus percent gains in the first 40 trading days is not what the real world is all about. March results remind us of this point.
Let’s take a look at some of the indices for a better picture. The Marijuana Index for March was virtually unchanged with the U.S. portion gaining 3.3 percent, while Canada was down 3.7 percent. If your preference was for ETFs, the Horizons Marijuana Life Sciences Index lost almost 5 percent.
The Nasdaq Composite gained nearly 2 percent. So for the first time this year, the average cannabis stock underperformed the general market.
There are two ways of interpreting these not-so-fun facts. After a great start to 2019, cannabis stocks are gearing up for a serious correction, or, after a great start to 2019, cannabis stocks are holding their ground very well. I fall into this latter group.
Rather than a serious correction, much of the data shows that investors rotated out of the big cap names that had been dominating the headlines earlier in the year. For example, Cronos Group (CRON) scored a 130 percent gain during the January/February period, then gave back 16 percent in March. The company’s Q4 2018 results, reported on March 26, were ugly, and that didn’t help. Nevertheless, a similar percentage loss was experienced by several of the other big cannabis names: Tilray (TLRY -18), Canopy (CGC -8), and Aphria (APHA -8).
After cashing in on the outsized gains, there is a good argument that investors rotated their holdings into many of the smaller cap names. The list of top stock percentage gainers in March include $126 million market cap Harvest One Cannabis (HRVOF +40), $91 million Speakeasy Cannabis Club (EASY.CN +32), and $680 million Village Farms Int’l (VFF +20). The one exception to this small-cap rotation was $9 billion-plus Aurora (ACB +22).
Perspective: Applying market theory
Investment theory holds that a market correction is defined by a pullback of 10 percent and the onset of a bear market as a decline of 20 percent or more. Obviously, this disqualifies March, even though most of the big cap names fell by more than 20 percent.
Normally when investors exit the big cap names, there is a far larger correction in the smaller companies. In March the reverse happened where the star performers are concerned. As you can see, the list included companies with little or no Wall Street coverage and thus is not well understood by mainstream investors.
Mixed news headlines
Forecasters of cannabis consumption have been painting a rosy picture for the next three, five, and even ten years. Many of these bold predictions were predicated on Canada’s legalization and the expectation that more U.S. states would follow Canada’s lead. It is the sort of thing that created the frenzy of deal-making in the first two months of 2019. This provided the energy for the huge price spikes that favored big cap names.
Pot pundits are likely to see their long term predictions come true. In the short run, however, cannabis related news has been just a bit more sobering. The best example comes from California, the largest U.S. market for adult and medical cannabis.
Late in February, The California Department of Tax and Fee Administration reported its cannabis excise tax generated $50.8 million in revenue, as noted in the 4th quarter of 2018. That is just slightly above third quarter levels. This was a big and unpleasant surprise considering 2018 was the first full year of legalization.
It also had to be a disappointment to investors looking to use the California model to extrapolate data to states that legalize cannabis in the future.
No one was suggesting that consumption in the Golden State was flattening out. It did however raise many economic questions about California’s high cannabis tax rate. Right now between the lower than expected income and the added costs of regulation, California will make almost nothing in the legalization process.
This sends a negative signal to legislators in other states considering legalization. A month’s long effort to legalize marijuana in New Jersey collapsed on March 25. According to The New York Times, the abrupt unraveling of the campaign to legalize marijuana reflected how some lawmakers were swayed by the experience of other states that have legalized cannabis.
What to do next
The March cannabis stock performance shows some encouraging signs for second tier companies. Even so, it would be a sign of good health for an industry wide correction in prices to take place. For believers in the bazillion dollar forecast for cannabis revenues in 2030, a 10 percent correction in the months ahead means very little. For those who have waited this long to get a toehold in the cannabis business, a correction would be a welcomed opportunity.