Don’t Fight the Tape: Cannabis Stocks Subject to Broad Market Swings

Don't Fight the Tape

Unless you’ve been hiding under a financial rock, you’ve seen just how volatile major stock indexes have been for the past week. It’s been a wild ride as the S&P 500, which represents the largest companies in America, has slid as much as 5% and risen nearly as much—in the same day! The Dow Jones Industrial Average had swings of over 500 points a day for four straight days, something not seen since the depths of the financial crisis in 2008-2009.

Investors may be lulled into thinking that stocks they own or study in the cannabis space are insulated from what’s happening in the broader market. But that’s simply not true, and violates one of the oldest maxims in investing: Don’t fight the tape.

The “tape” here refers to what is going on in the broader indexes. If, for example, the S&P 500 or the NASDAQ is down 2% on the day, the odds of a cannabis stock rising in price that particular day is very, very low. Unless the company has some specific news or catalyst affecting it that has just come to light, one can expect that the stock will be down along with the broader “tape.” The expression comes from Wall Street days of yore when stock prices literally came out in a long roll of ticker tape, tick-tick-ticking throughout the day. Prices of stocks tended to move in concert then, and 100 years later it’s the same story.

 

Look at the Correlations

All that is needed to prove this point is to look at how closely a basket of cannabis stocks has tracked against the NASDAQ over the past week. We are using the NASDAQ in this example because its nature as a higher growth, higher risk index of companies is most relevant to what the average cannabis investor faces.

In late August, the NASDAQ was in the midst of a very tight trading range, but had consistently closed above 5000 after hitting that level for the first time in 15 years in March. After bouncing around the 5000 level for months with little volatility, here is what happened this past week:

NASDAQ-Aug-Drop-Web

And this chart only shows closing values—intraday charts would show an even more volatile picture, as the NASDAQ measured high to low priced off more than 10% in the past week. As we can see from the Marijuana Index Global Composite, pretty much the exact same swing happened in the cannabis sectors:

MJIC-Global-Aug-Web

The index fell over 10% in just a few days, then made a strong bounce off the lows seen on August 24-25.

The correlation between the NASDAQ and the cannabis index over this period is extremely high, at over 90%. The tight correlations start at the top—leading names like GW Pharmaceuticals (NASDAQ: GWPH) and Insys Therapeutics (NASDAQ: INSY) saw swift declines last week before bouncing back, again in line with what we saw in the broader stock indexes.

It’s not just U.S. stocks that follow this maxim; in today’s interconnected economy most nations’ stock indexes tend to move in line with ours, especially those with strong trading partnerships. Canadian LPs like Tweed Marijuana (CVE: TWD) and Mettrum Health Corp (CVE: MT) both saw their stocks decline by more than 10% this week, in very similar price action to domestically domiciled firms.

There are two elements that also reinforce the tendency for stocks to rise and fall together in the short term. One is based on high-octane money managers who handle huge sums of money and move it around very fast. They have the tools and mentality of pushing the issue, so that when a downtrend or uptrend starts to form in one area, they look to move nearby market opportunities the same way. The trading volumes they bring to the market often dwarf the aggregate volumes of the retail investors, the individuals making trades with their personal accounts.

The other element is more psychological, or behavioral in practice. If one area in our portfolio is suffering a loss, we’re more inclined to sell other assets, even if they’re totally unrelated to the ones that are falling. It tends to make people feel safer, that they’re battening down the hatches so as to prevent further losses. This fact has borne out in just about every bear market in history, and any investor can relate to the feeling of “what’s next to drop?”, and preemptively selling off assets.

 

Keep an Eye on Beta

Beta is a financial measure of how much a given stock moves relative to a benchmark like the S&P 500. Most financial sites will show the beta on a stock’s main page, along with price, volume, etc. A Beta of 1 is considered “market average,” and the number is calculated based on the previous months’ worth of price activity in the stock. So if a stock has a beta of 1.5, then it is expected to move about 50% more in a given direction than the benchmark index. So if the index were to be up 1% on the day, the stock would average about a 1.5% gain.

While technically considered just a measurement of a stock’s volatility, Beta is actually a measure of risk. Intuitively, this makes sense if you think about risk as being nothing more than the chance that you lose your money. A stock with a high beta in a down market is a stock with a greater chance of plunging. Cannabis stocks have some of the highest beta values in all the market, which is the market’s way of telling us just how murky the future of the cannabis industry truly is.

 

Over Longer Time Periods, Company Specifics Matter

While most stocks within a similar class will generally move together over short time frames, and during periods of high volatility, when the time frame is extended is when we begin to see companies deviate. Individual, company-specific catalysts like new products, management changes, earnings releases, etc., all will come to dictate the price of a company’s shares more than the price level trends in the broader indexes.

So for a long-term investor, the most important thing is almost too simple to be true: just think like a long-term investor. Be honest with yourself about time horizons. If you’re looking to just “make a trade,” then you better be sure that there is a specific catalyst around the corner that you are hoping to take advantage of. Otherwise you should be prepared for your investments to perform along the same trendlines as the NASDAQ or the S&P 500.

If you’re in the long-term investor camp, then be prepared to stay invested for two to three years minimum. That would be true of any sector, but probably more so in cannabis. Even if we woke up tomorrow to a world with legalized cannabis, the smart play would be to stick around for a few years, and see how your favorite company is able to navigate the massive opportunities ahead.

 

 

*Author holds no shares of any companies mentioned in this, or any of his articles. All opinions stated here are for informational purposes only. Investors should do their own due diligence before investing in any industry, especially in high-risk areas like cannabis.

Ryan has spent nearly 20 years analyzing financial markets and investment opportunities for institutional and high-net worth investors. He specializes in determining the size and scope of new markets, changing industry trends and the market potential of new companies, products and services. Ryan has also published hundreds of articles on investment topics, market commentary and macroeconomic analysis.

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