By Alan Brochstein
Summers are usually tough on OTC stocks, and, by extension, the cannabis sector, as almost all of the stocks trade on the OTC, which sees volumes typically fall during the vacation season. 2016 is likely to be different for cannabis stocks, though, as the election season should be a major draw for speculative traders. We saw minor rallies in 2015, when Ohio voted on legalization (failed), and in 2014, when Alaska, Oregon and Washington, D.C. voted on legalization (all passed) while Florida voted on medical cannabis legalization (failed). In both years, the sector experienced positive returns in October, suggesting that traders set up in advance of the elections.
Cannabis stocks have finally emerged from a severe downturn. After a collapse of 97% from the peak in March 2014 to the trough in February 2016 as measured by the 420 Investor Cannabis Stock Index, prices have shown signs of life over the past few month. Through May, the index is roughly unchanged in 2016 at 38.09, which is down 3.0%. For some perspective, here is how the market has performed in 2016, with a very solid 63% move from the lows in February to the peak in April:
This election season looks to be the biggest one ever in terms of the populations of the states involved. While not all of these are definitive, there are likely to be ballot initiatives for full legalization in California, which has more than twice the residents of legal states Alaska, Colorado, Oregon and Washington combined, as well as Arizona, Maine, Massachusetts, and Nevada. Each of these states already has a medical program in place. Florida will again be voting on medical cannabis. It's a presidential election, so there is likely to be significant media attention on these state votes. Additionally, the legalization movement, which has so far been limited to the West, could take hold in the East, where states are more populous and close together, suggesting a potential tipping point for the legalization movement. Already more states have medical cannabis programs than those that have none.
If one accepts the premise that traders will focus on the cannabis sector, it's important to nail down the timing. At 420 Investor, I have long been suggesting that the trade will start much earlier than November, perhaps in early September. I have noticed a trend over the past three years that I have been following the cannabis sector that suggests an interim trough in the market may actually occur in mid-August, when the companies on regular calendar year-ends report their Q2 financials. These reports are typically met with negative responses, as traders/investors see the lack of fundamental progress. The important point is that the time to sell not buy will be in November. Yes, sell the news, even if it is good.
So, now having established that there will likely be an event-driven trade in the cannabis sector and that one should likely position well in advance, the obvious challenge is to figure out what to buy. There is no cannabis sector fund or ETF, so one will have to pick stocks. Typically these election trades work best in the more liquid names, which have tended to be the same old names with the cute tickers like "ERBB", "HEMP" or "MJNA", but, fortunately, are a lot broader these days. In fact, some of the companies that I think stand out against the sector in terms of their potential have achieved greater liquidity than in 2015. I expect that traders will look for a pattern of good trading volume but also stock prices that aren't at their lows but are far from their highs. So, the inflows are likely to be somewhat broad, but there are some companies with higher than average quality that I will be focused on, as I expect that they will participate in the trade.
One name in particular that I find interesting is Terra Tech (OTC:TRTC), which has great positioning for the elections as it operates in California and Nevada, both of which are likely to not only be on the ballot but to also get approved by the voters. TRTC certainly has liquidity, but the stock is already up substantially in 2016, though it has pulled back from the April highs. This stock is likely to be very volatile and is one to watch in the Summer for potential entry.
Make no mistake about cannabis stocks: They are extremely speculative. The legal cannabis industry is performing well, but the stocks, for the most part, don't really reflect the underlying industry. The market seems to be finally figuring this out, so the liquidity is starting to improve in some of the higher quality names that have struggled to resonate with traders. The big trade I envision in the Fall is likely to benefit some of the same old scoundrels that have been trading for years but making no progress but also some of the names with relatively higher quality.
Editor's Note: Alan Brochstein, CFA, began his career as a bond trader in NYC in 1986 with Kidder, Peabody and worked with CS First Boston and Criterion investments until transitioning to equities as a analyst/portfolio manager in 2000. In 2007, he began AB Analytical Services, where he provided research and consulting to several investment advisors while also becoming one of the most popular contributors at Seeking Alpha. In 2013, Alan launched 420 Investor, an online community focused on publicly-traded companies in the cannabis sector, and, more recently, he began New Cannabis Ventures, a news & information platform that highlights the most promising companies and influential investors in the cannabis industry.
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