2021 is history and today I am dropping in to share a recap of the cannabis sector in 2021 and my outlook for 2022.
2021 was a tough year for the cannabis sector. The Advisorshares US Cannabis ETF (MSOS) fell 60% from the 52-week high and closed down 32% on the year.
Take a look at the chart below of the second half of 2020 and the full year of 2021. Cannabis stocks ripped higher in 2020 only to give all those gains back in 2020.
*Chart from Tradingview.com
Naturally investors want to know what happened. I see two reasons for the big decline.
Two Reasons Cannabis Stocks Struggled in 2021
The threat of high federal taxes: At this point everyone knows that federal legalization is going to happen. It’s already priced into the market. The sticking point here is, when legalization does happen, what will federal tax rates look like? Right now it’s not looking real great. Senate leader (D- New York) Chuck Schumer rolled out a federal legalization bill this summer that included a 25% federal tax rate within a few years. This high tax rate meant this bill was dead on arrival, it had no chance of passing. None the less, Schumer vowed to block every single piece of cannabis legislation until his bill gets passed and that’s what he has done.
Despite holding the presidency and both chambers of congress Democrats didn’t pass any federal cannabis bills in 2021. Cannabis stocks didn’t react well to any of this news. When Schumer’s bill hit the wire in late July cannabis stocks fell sharply and proceeded to fall close to 50% in the next four months.
California legal cannabis industry on the verge of collapse: California is the largest cannabis market in the world and the U.S. Right now California does about $12 billion in cannabis sales per year. $9 billion is from the illegal market and $3 billion comes from the legal market. California is the most important market for the success of the U.S. cannabis industry. After going legal in 2017, the California legal cannabis industry is on the verge of collapse because high taxes and regulations make it virtually impossible for the legal industry to compete with the well established and deeply rooted illegal market. Here are some more details in a report from AP.
Leading California cannabis companies warned Gov. Gavin Newsom on Friday that the state’s legal industry was on the verge of collapse and needed immediate tax cuts and a rapid expansion of retail outlets to steady the shaky marketplace.
The letter signed by more than two dozen executives, industry officials and legalization advocates followed years of complaints that the heavily taxed and regulated industry was unable to compete with the widespread illegal economy, where consumer prices are far lower and sales are double or triple the legal business. Four years after broad legal sales began, “our industry is collapsing,” said the letter, which also was sent to legislative leaders in Sacramento.
The industry leaders asked for an immediate lifting of the cultivation tax placed on growers, a three-year holiday from the excise tax and an expansion of retail shops throughout much of the state. It’s estimated that about two-thirds of California cities remain without dispensaries, since it’s up to local governments to authorize sales and production.
The current system “is rigged for all to fail,” they wrote. “The opportunity to create a robust legal market has been squandered as a result of excessive taxation,” the letter said. “Seventy-five percent of cannabis in California is consumed in the illicit market and is untested and unsafe. “We need you to understand that we have been pushed to a breaking point,” they told the governor.
Here’s a link to the full article if anyone wants to take a look.
California Pot Companies Warn of Impending Industry Collapse
What Should We Expect Moving Forward?
Things are rough for the U.S. cannabis sector but there is still a light at the end of the tunnel. I see a few potential catalysts in the first half of 2022.
Cannabis stocks are grossly undervalued: After the sell off in 2021 cannabis stocks look grossly undervalued relative to current growth and projected future growth.
More states going legal in 2022: In 2021 four states legalized cannabis, Connecticut, New York, New Mexico and Virginia. 2022 should see another wave of legalization, with many states signaling a desire to go legal and lawmakers releasing bills. That includes Pennsylvania, Ohio, Delaware and Maryland.
Potential tax relief in California: San Fransisco has already begun offering tax relief to the cannabis industry. We need to see a lot more of this spread across the state. If we did, it could be a big catalyst for cannabis stocks.
San Fransisco Suspends Cannabis Tax to Combat Illicit Market
A federal cannabis bill with lower tax rates: Federal tax rates for the cannabis industry are still being debated behind closed doors. Hopefully lawmakers are negotiating these tax rates down a lot lower. For example, alcohol has a 3.75% federal tax. That would be a lot more reasonable than the proposed 25% federal tax on cannabis.
Cannabis stocks have traded in this annual pattern: The cannabis sector has been very boom and bust for the last few years. The sector has a great year, and then the next year it falls back lower. This has definitely been frustrating for a lot of investors. The good news here is that cannabis stocks are coming off a year of weakness. In the past this means a good year is on tap.
Here is the Plan Moving Forward
Cannabis stocks are one of the most volatile sectors in the entire stock market. These stocks are suitable for investors who can handle short-term volatility, for potential outsized gains in the long run.
As we move into 2022 the plan has been to trim down on cannabis holdings and reduce allocations. The goal is to get more conservative in the short run, and in the long run if something changes we can get more aggressive. But for the time being I have been de risking portfolios on all fronts, and the includes cannabis stocks.
I’ll be back with another update next week – have a great day!
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.
