Cannabis stocks have exploded over the past twelve months, surging substantially in hope that the United States will soon legalise cannabis on a federal level.
But for now, the law surrounding the plant remains ambiguous, which could suggest the recent market rally is more of a speculative hype-driven bubble as opposed to organic market growth.
A stock market bubble is defined as an economic cycle characterised by the rapid escalation and subsequent deflation after a set of similar stocks are driven above their value in relation to their rational value. When investors heed in purchasing at the new elevated price, a huge sell-off occurs, causing the bubble to deflate.
The first-recorded example of a speculative bubble occurred in the Netherlands in the 17th century. It is commonly labelled as ‘Tulip Mania’ as it saw the price of tulips skyrocket to above its expected value before dramatically crashing in the space of seven months.
The cannabis stock bubble could blame the vast inflation it has experienced on over-estimates about the future forecasts of the industry, with some estimates ranging from $500 billion to $1 trillion, with the realistic range most probably around the $150 billion mark predicted for 2029.
Aurora Cannabis (ACB) rose by 125% from the turn of the year to March, but it has since dropped by 45%, indicating that the optimism that once fuelled the market is beginning to wane.
Aurora Cannabis looked set on creating a deal with Coca Cola (KO), which would have seen a boost in investor interest within the industry, however the CEO Terry Booth stated recently that the company focus was not on the beverage market due to limited success of cannabis beverages already available on the market.
Despite the demand for such beverages, several large-scale brands are still worried about the stigma of getting involved with cannabis and the potential of damage reaching their mainstream image.
Charlotte’s Web (CWBHF), on the other hand, has defied the sceptics by preserving its early-year gains of 125% despite suffering a minor blip in June.
Charlotte’s Web has seemingly taken full advantage of the new lenient hemp laws introduced by increasing their production and expanding into more than 8,000 retail locations including major chains such as CVS Health and others across the US.
The company planted 862 acres of hemp during the 2019 growing season in order to meet growing demand, representing a 187% increase since 2018.
Producing a variety of wellness-based products containing hemp-based CBD with offerings of oils, gummies, capsules and even pet products, the company leads the market by far in terms of market cap.
It seems as though CBD companies are finding it easier to achieve success within the markets over cannabis-based companies. This may be due to the 2018 Farming Bill, which gave investors solid confidence to venture into these markets over the unpredictable cannabis industry and the legal uncertainty that surrounds it.
But as stocks look delicately poised over the coming months, what are the fundamental issues driving this infant market?
Laws and regulation
The FDA’s categorisation of CBD products will be a key indicator for traders looking to capitalise on pot stocks over the next few months. The food regulator has been seeking comments from industry professionals and will release guidance before the end of the year.
As for cannabis, it is currently legal in Colorado, Washington State and California among others, with states such as Texas moving towards decriminalisation.
The federal stance on the plant still seems fairly strict, with citizens getting stopped at the border and banned from entering the country just for carrying medicinal CBD.
Uncertainty in legal frameworks drives volatility in the markets – one statement from a government or senate official could be catastrophic, or groundbreaking for cannabis-related companies.
Celebrities have hopped on the CBD bandwagon over the past year, Kim Kardashian hosted a CBD themed party for her daughter while the likes of Jennifer Aniston and Oprah Winfrey have also endorsed their own favourite products.
While it might seem irrelevant to the markets, celebrities actually have a huge influence on the price of stocks, via influencing their army of followers on their opinions of certain companies.
Kim Kardashian’s sister, Kylie Jenner, tweeted negatively about Snapchat, prompting the company to lose $1.3 billion in market cap in a day. It has struggled to recover ever since.
Jenner simply wrote a tweet asking ‘Sooo does anyone else not open Snapchat anymore? Or is it just me… ugh this is so sad.’ Subsequently, this caused a massive haemorrhaging of users from the popular app, with many deleting Snapchat completely off their devices.
It’s been reported that short sellers made more than $1 billion betting on the stock’s slide after the infamous tweet.
Future for the market
Many large investors and companies with involvement in the industry are most likely waiting for the huge market to mature and see consolidation take place before making solid assumptions about the future of cannabis markets.
To help drive the market further, giant conglomerate consumer companies such as Coca-Cola (KO) and Walmart (WMT) could invest more in the sector, though they’ll probably wait for legalisation before confidently joining the business.
Another challenging factor can be the informative battle which comes with marketing CBD products, with a number of companies being scrutinised for incorrectly labelling products and aggressive marketing tactics.
Currently, many in the industry feel like they’re fighting an uphill battle as they try to slide the reputation of hemp and CBD away from pot smoking hippies, while trying to convince medical professionals and interested citizens about the beneficial aspects of CBD and how its different from the commonly known cannabis.
If regulators decide to clamp down on the industry, we could see signs of the cannabis bubble beginning to pop, but for now optimism is on the up and endorsement is at an all-time high, so it’s logical to think that cannabis will continue to surge in the coming years as the market begins to mature.