The third quarter of 2019 is over – today I am dropping in to share a quarterly update on cannabis stocks and my outlook for the rest of the year.
Cannabis stocks struggled in the third quarter. The entire sector, even the most credible names were under pressure.
The cannabis stock mutual fund Alternative Harvest ETF (MJ) fell 34% in the third quarter.
Sector leader Canopy Growth Corp (WEED, CGC), the largest cannabis company in the world, fell 40% in the fourth quarter.
The broader cannabis sector is now down 21% in 2019, while Canopy is down 22%. As you can see in the chart the sector was off to a ripping start early in the year before faltering in the spring and summer.
As you can see it’s been a very tough stretch for cannabis stocks. This is one of the longest and deepest bear markets the sector has ever seen.
There were a few key events that triggered the weakness.
Why Were Cannabis Stocks so Weak in the Third Quarter?
Cannabis sector was overbought: Even after the decline, cannabis stocks are still up huge in the last few years. For example, even after the recent decline Canopy is still up almost 1,000% since 2016. This pullback looks like a breather in the long march higher.
Canopy fell short of expectations: Sector leader Canopy reported a string of bad news. Founder and long-time CEO Bruce Linton was fired. Then Canopy reported disappointing second-quarter results that fell short of expectations. Even though these kind of speed bumps are totally normal for sector leaders in high-growth industries, Canopy fell sharply on both events and dragged the entire sector lower.
The Vaping Scare Took a Huge Toll: And finally, the recent vaping crisis took a big bite out of cannabis stocks. More than 1,000 people became sick from vaping in the last months, and 19 people have died. This triggered a major concerns about the safety of vaping. Massachusetts went as far as banning vaping. This news had a huge negative impact on cannabis stocks – investors were pricing in a lot of bad news. Investors started pricing in a worst-case scenario around vaping and the cannabis industry.
Naturally the big question now is: what should we expect moving forward?
What Should We Expect Moving Forward?
Despite the tough quarter I am expecting a strong rebound and close to the year.
I see a string of powerful catalysts directly on the horizon.
Cannabis Sector was the Most Oversold it Has Ever Been: After the recent sell off the cannabis sector was the most oversold it has ever been. This is a very big deal. A lot of investors that had been wanting to get into the sector are using the pullback to jump in. Long-term investors are using the dip to add more shares.
Shorts are Closing their Trades: Cannabis is one of the most shorted sectors in the stock market. Short sellers have been hammering cannabis stocks for the last few months, driving shares lower with a wave of selling. Shorts just saw a big move to the down side – they have scooped up some nice gains. Now, it’s time to take some profit. That requires shorts to buy shares back, driving the price of shares higher. I am expecting to see more short covering and I expect it to keep a bid in shares.
Vaping issues related to black-market: The people getting sick from vaping were buying black-market vapes that were spiked with toxins. The scientific community has already proven with research and data that vaping THC isn’t a big health threat and way less toxic than smoking cigarettes.
Seasonal Effect: Cannabis stocks have a history of being weak in the summer, and then rallying big in the fall and the end of the year. We’ve seen this happen in two of the last three years. With the sector being so oversold right now, we have a really nice setup for another big, year-end rally.
Canada 2.0 in October: Canada legalizes cannabis extracts in October and sales are expected to kick off in the fourth quarter. Even though Canada went legal in 2018, extracts are still illegal. Anyone who knows anything about weed knows that extracts are freaking huge. Cannabis oils and vape pens is the fastest growing segment of the cannabis market. Legalizing extracts is expected to almost double the size of Canada’s cannabis market. This be a strong tail wind for Canadian cannabis stocks for the rest of the year.
The Cannabis Friendly STATES Act: Cannabis companies are currently banned from banking services. Its a huge drag on the industry. The STATES act would change that – allowing cannabis companies to bank at places like JP Morgan and Bank of America. This bill has a lot of support – there’s a good chance it gets passed this year. If it does – I would expect it to give cannabis stocks a major jolt.
More US States Going Legal: The wave of legalization in the US is accelerating. Illinois goes legal on January 1. New York and New Jersey, two of the largest cannabis markets in the world, almost legalized this year and are expected to close the deal in 2020. Ohio is about to pass a ballet initiative for 2019. Arizona and Florida are expecting ballet initiatives in 2020 – I see both states going full legal by the end of 2020.
The Big Picture and How to Play the Trend
After a tough bear market, I see a string of positive catalysts hitting the cannabis industry in the fourth quarter.
As we have seen cannabis stocks can rally very big, very fast. And historically speaking, the best time to buy the sector is when it’s way down.
I Already Own Cannabis Stocks: Sit tight with current holding and think about adding more shares of US cannabis stocks. Try not to worry about short-term volatility too much.
I don’t Own Cannabis Stocks: Call me or email me.
I’ll be back in a few weeks with another update – in the meantime let’s look for a big bounce in cannabis stocks in the fourth quarter.
Disclaimer: This report is for entertainment purposes only. Every investor should consult with an investment advisor before making investment decisions. The Vodicka Group, Inc. is not a broker/dealer. We do not receive compensation for mentioning stocks. At various times, the clients, publishers and employees of Vodicka Group, Inc., may buy or sell the securities discussed for purposes of investment or trading. Michael Vodicka owns shares of Canopy Growth Corp (WEED) at time of writing.