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Overbought cannabis stocks: What to consider when prices are soaring

No sooner has the ink dried on January’s impressive cannabis stock price performance then February starts off with even better performance.

Will it continue? Perhaps for a while, who knows? Predicting day to day performance of stock prices is a fools game. But things are beginning to look, taste, and smell increasingly speculative.

To be a successful investor, it is important to avoid doing anything (buying or selling) because it makes you feel good. It likely is an emotional trap.

Let’s take a quick look at today and where markets stand. At the time of this writing just about all cannabis stocks are up strongly. The Indices tell the story. The Horizons Marijuana ETF is ahead 7.3 percent and continues to gain momentum.

[Aurora Cannabis, Canopy Growth surge Monday on strong day for marijuana stocks]

Market leaders like Cronos Group (CRON + 16.2 percent) Aphria (APHA +11.47 percent), Aurora (ACB +9.5 percent) and Tilray (TLRY +7.12 percent) are leading the pack. Of the 30 cannabis stocks on my screen, only six are in the red.

Secondary names like KushCo (KSHB +7.54 percent) and Emerald Health Therapeutics (EMHTF +12.1 percent) are being gobbled up just as eagerly.

420 SCIENCE from Potnetwork on Vimeo.

What’s it all about?

It is always good to see stocks of any type up especially after last September. Starting at that time and continuing through the end of last year, the HMMJ dropped 50 percent. So today's prices are a welcome event for investors.

All this is true, but today’s performance mirrors what has been going on so far this year. Since the end of 2018, cannabis stocks have been the star performers. As we noted in a recent piece titled “A Fond Farewell To January,” most indices recorded a 44 percent increase in the first month of this year.

Critics will rightly point out that Cronos with an 89 percent increase played a heavy role (most indices are market weighted.) Without CRON, cannabis stocks still outperformed the sizable 9.5 percent gain of the Nasdaq Composite.

[Namaste Tech fires CEO Sean Dollinger amidst allegations of fraud, breaches of fiduciary duty]

By the way, that same 9.5 percent gain was achieved by the ordinary old Dow Jones Industrial Average and the S&P 500. So it is fair to say that the stock market has been very good to investors. However, one important thing separates cannabis from everybody else.

Horizon's ETF/ Source: HMMJ

An important difference

If there is one key force behind this year's performance of the Dow, Nasdaq, and S&P 500, it is interest rates.

Nothing kills a stock market rally quicker than when the US Federal Reserve increases interest rates. After months of worry about possible aggressive interest rate policy, the Fed has made it clear. They will be going slow on rate increases this year. That news is all investors needed to pile back into the market.

The level of interest rates affects everyone. The cannabis industry, however, is better insulated than about any other from the vicissitudes of interest rates. To confirm this point, just look at the deals like Altria (MO) or Constellation Brands (STZ). Cash is pouring into the cannabis business. More than anything else cash appears to be the driving force behind cannabis stock pricing.

Other than positive investor expectations, there is no single event to explain today’s performance. If you doubt this, just do a Google search for “Today’s Cannabis News.” The first three stories are commentaries on how impressive stocks are gaining. That is not a good reason to be buying stocks.

[Marijuana stocks weekend investor roundup: Analysis of the week's most important events in the cannabis industry (February 2)]

In fairness to all sides, there is one market anomaly to consider. Studies have shown the earnings report expectations tend to boost stock prices temporarily. There is a lot of evidence to support this conclusion. But there is one important difference.

Earnings (where they exist) of cannabis companies are irrelevant. There is massive unsatisfied demand that will be around for years. So even placing much near term importance on revenue levels seems a bit overdone. The most important thing today is getting the so-called supply chain and branding established.

Cuidado

There is a word in Spanish, cuidado. It means both “attention” and “watch out.” This word is appropriate for cannabis investors. After the index has moved up almost 50 percent since New Year’s Day, chasing further performance could cause damage to your financial health. It is important to remember, in the 80 days between October 15 and Christmas Eve last year; cannabis stock indices dropped 50 percent.

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