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Is Tax Loss Selling Creating a Buying Opportunity in the Cannabis Sector ?Submitted by Justin Hayek on November 21st, 2019
Tax loss selling is a proven strategy used by investors to reduce their tax bill. It can be employed at any time during the calendar year up until the tax loss selling deadline (December 27th this year). Though this is the case, most investors wait closer to the deadline to crystallize their losses. There is something about December 1st where and when investor psychology shifts towards 'tax loss selling mode'.
In years past you may have seen this yourself, particularly within the mining sector when it has performed poorly over the calendar year. Come December investors look to crystallize losses capturing the net-tax benefit of a tax loss. This then puts selling pressure on the various mining issuers leading up to the tax-loss selling deadline followed by seller exhaustion and then re-accumulation of names in January after 30 days have elapsed.
I believe we could see an acceleration of tax loss selling in the cannabis sector heading into the deadline of December 27th followed by a pick up in the sector (though perhaps just short term). Anecdotal support of this:
- the cannabis sector, as represented by the Horizons Marijuana Life Sciences Index ETF (HMMJ-T) is down approximately 37% year to date and down 62% from its year high! The average buy on HMMJ was at ~$15.25 per share as represented by the 1 year VWAP (volume weighted avg price). Meaning the average buyer this year is likely down 40% on their HMMJ position.
- talking to other advisors, general consensus is that most have not had many conversations with clients regarding tax-loss selling, yet.
- volume has started to pick up in a meaningful way, meaning HMMJ is beginning to see higher weekly volume than average. This suggests to me tax-loss selling has begun and this could very well accelerate..
- However, I believe tax-loss selling is not yet in full effect. This will likely occur in the week or two before the deadline as we've seen in previous years.
- Timing for those tax-loss sellers could not be worse as the days leading up to the Christmas holidays and New Year are the quietest and least liquid, that is fewer investors looking to buy stock. For these tax-loss sellers than, they may be very well selling into fewer buyers creating unsupported selling pressure and exaggerating a stock's movement to the downside.
This is where a short-term opportunity is being created for patient investors but you should only consider investing in the described issuers if you have a high tolerance towards risk as the above investment thesis may not play itself out as described or thought.
Caveat emptor: there are a number of cannabis companies which are trading down for good reason - the company requires financing or the business is poorly operated. Talking to an industry insider recently, he said he believes 50% of the existing cannabis companies won't be around in the next year.
This idea of a washout in the sector with a subsequent potential rally is also being explored in the media. See this Bloomberg article.
For the reasons mentioned above, I have carefully prepared a 'cannabis shopping list' as I believe we could see a rally post tax-loss selling deadline but only amongst the highest quality issuers.
To avoid the bad companies and to narrow my shopping list to a select few companies that are deemed best in class operators, I have been talking to our cannabis analyst and a colleague who is a director of a dedicated cannabis hedge fund in Canada. Getting a sense for the best companies and therefore first choice as cannabis investments is important.
Taking it a step further, I pared down the list to well-financed issuers, that is companies with significant cash & cash equivalents giving them the ability to make it through this very challenging financing environment and lower probability of near-term shareholder dilution (financing risk).
My shopping list of cannabis companies is a mix of 9 Canadian and US businesses within various segments of the sector:
- well-funded, large scale, licensed producers in Canada
- an extractor
- a retailer (bricks & mortar locations)
- US & international vertically integrated operators (from seed to sale)
- and a US consumer packaged goods company (production, branding, marketing of final product)
The list has a 60-40 weighting between US and Canadian operators. By investing across a number of different issuers, segments and geographic regions we are reducing single security risk and selecting the incorrect segment.
In my next blog post, I will break down my cannabis shopping list further by providing insight into the individual businesses and characteristics of their stocks.
If you want to connect with me and discuss these investment opportunities or others send me an email to firstname.lastname@example.org