The Good, the Bad and the Ugly
I’ve been trading for almost thirty years – through the Asian contagion and LTCM, the dot.com bubble and bust, and on both sides of the global financial crisis – and the volatility in the cannabis complex has been tough to stomach, even for me. We’ve discussed the drivers behind this, and our belief that Wall Street coverage will transition ownership from retail holders to institutional accounts, but we’re still early in that process and the journey remains bumpy on a month-over-month basis.
When the Dow Jones Industrial Average crashed in October 1987, it lost 22% in a single day. Over eleven sessions during the second-half of October 2018, Canadian cannabis proxy HMMJ lost 40% of its market capitalization, while industry leaders, such as Aurora Cannabis, lost more than half of their entire value.
So yes, cannabis stocks crashed in October, and that took the shine off sentiment, and then some, and paradoxically, that is constructive on the margin.
Let’s frame our monthly correspondence in three buckets:
There were several positives in October, including the eradication of the froth in the cannabis sector and an opportunity to add portfolio companies at lower prices. We also were fortunate to have converted approximately 15% of our portfolio to cash at the beginning of the month as we set that money aside for select U.S. operators that were / are coming to market; in the process, we exited several favored, albeit extended, positions and we were able to rebuild that exposure at meaningfully lower price points.
Some of the world’s leading researchers gathered at CannMed 2018 to discuss efficacy-driven cannabis-based therapies and solutions. This comprehensive UCLA-hosted event served to strengthen our resolve that while we may be early in the clinical processes, the range of indications and breadth of disruption will be immense; perhaps greater than we previously foresaw. We will continue to follow the science and we remain excited by where we believe it will take us.
Finally, Republican members of Congress have said that they have received assurances from the White House that “the president intends on keeping his campaign promise” to legalize medical cannabis at the federal level and leave recreational use up to the States. Whether this is proven true remains to be seen, but we continue to anticipate U.S. decriminalization and banking reform as forward catalysts for our stateside holdings.
At the end of our last letter, we said that “we remain focused on finding solid companies with strong management and an aligned vision; and we’ll trust the market to sort the rest out.” We checked the first box, or so we thought, but the selling in our sector was pervasive and indiscriminate, triggering technical damage across the entire cannabis spectrum.
There was Curaleaf, the U.S. operator that came public into the teeth of the October decline and was down 40% on its first day of trading (we were allocated stock in the offering). There were some extenuating circumstances, such as a late upsizing and a healthy valuation, but this will be used as ammunition by the bears until the stock reclaims the deal price. We saw similar price action from MedReleaf when it came public in 2017 and sense a similar script, which suggests the stock will work higher over time.
Also, we owned 5% positions in both Ianthus Capital and MPX Bioceutical when they announced their merger and we didn’t sell any stock. That proved to be a detractor from performance as they were subsequently sucked into the October abyss, but we have made a conscious decision to hold both stocks given their combined value, national footprint and superior management teams. We stand by that decision.
Here’s a sampling of the percentage losses in the cannabis universe during that eleven-session span:
Canada: Aurora -57%, Tilray -53%, Cronos -50%, CannTrust -48%, Canopy -46%, Hexo -48%, Aphria -40%, Organigram -42%, Village Farms -37%.
U.S.: Green Thumb -47%, Trulieve -46%, Ianthus Capital -37%, Liberty Health Sciences -35%.
Biotech: GW Pharmaceuticals: -21%, Corbus Pharmaceuticals -25%, Vitality Biopharma -35%.
The broader market had a rough time, too. The NDX 100 and S&P lost 15% and 11%, respectively, at maximum drawdowns, and the damage under the hood was worse, with semiconductors (SOX), biotech (XBI) and housing (XHB) losing ~20% or more at their respective nadirs.
Entering the final two months of 2018, the BI Global Competitive Peers Index was 55% below its January high, with the long-term trendline support 17% lower still. While the confluence of trendlines overhead is worrisome on the margin, we know that prices are subject to change, which is why we incorporate technical analysis as one of four primary metrics.
We believe the sharp, painful downdrafts, such as what we saw in October, allow for the transfer of ownership in our sector from retail holders to institutional accounts. We further believe that U.S. decriminalization is much closer than most people think; when John Boehner is on Bloomberg Radio advertising his “marijuana picks,” we figure we must be getting close.
The closest parallel to what we’re about to witness is the dot.com bubble and bust; and we could all agree that if our top holdings enjoy a “FAANG”-type run, we would certainly take it. But even those success stories were littered with false hope, empty promises and plenty of gut-wrenching turns. Amazon and Apple both had 90% drawdowns, and that’s the bull case, vs. the fate of Pets.com.
Having run this strategy for almost a full year, we believe we’re exactly where we’re supposed to be: in possession of ~13M shares of the stocks we believe will win, “stopped out” against the science, and laying in wait for an efficient marketplace. And we’ll continue to keep 1-5% of AUM in non-correlated put strategies to help buffer the downside if the U.S. markets continue to lower.
We believe the disruption we’ll see—from beverages, nutraceuticals and consumer packaged goods, to the efficacy-driven solutions—will be an economic force so vast that it will shape future business cycles and provide opportunities to create generational wealth, and we’ll continue to look through the near-term smoke until we arrive at that destination.
As always, we look forward to answering any questions that you may have.