Canadian pot stocks appear to be in for a particularly rough day today. As proof, shares of Aurora Cannabis (NYSE: ACB), Canopy Growth Corporation (NYSE: CGC), and Cronos Group (NASDAQ: CRON) all fell by at least 10% in pre-market trading this morning. What's the driving force behind this latest widespread sell-off in the cannabis space?
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Fortunately, Aurora, Canopy, and Cronos' shares aren't dropping in response to a company- or industry-specific event. No, these high-flying pots stocks appear to be falling victim to a host of macroeconomic and geopolitical concerns that are weighing on stocks in general today.
Chief among these various headwinds is that some top economists are sounding the alarm that the U.S. economy could start to cool off in a big way in 2019 — and perhaps even go into a full blown recession by 2020. This dire claim is based largely on the yield of the five-year Treasury note falling below that of the three-year note last Monday. This so-called "yield curve inversion" has been a fairly reliable indicator of incoming recessions and economic slowdowns ever since the end of the second world war.
What does this economic warning signal have to do with pot stocks? Canadian pot stocks have been exploding higher over this year thanks to Canadian's decision to end prohibition on the drug for recreational purposes among adults earlier this year. Unfortunately, this landmark event may have inflated an industrywide bubble.
Aurora, Canopy, and Cronos, after all, have all seen their shares trade at enormous premiums this year — premiums that simply aren't supported by their near-term fundamentals. As such, it's not surprising that investors are backing away from companies with bloated valuations ahead of a possible downturn in the economy.
The good news is that cannabis stocks may get a much-needed boost from more high-dollar partnership deals in the near future. Tobacco giant Altria, after all, is reportedly in talks with Cronos about a strategic partnership. And several big names in the beverage industry have expressed interest in possibly jumping into the cannabis sector through a partnership or acquisition as well. Earlier this year, Canopy became the first pot company to attract a major equity investment from beverage-maker Constellation Brands.
That being said, Aurora, Canopy, and Cronos may all struggle if the global march toward widespread legalization slows down — regardless of their ability to attract big-time partners. The Canadian pot market, after all, simply isn't large enough to support these types of lofty valuations — making it absolutely critical for these cannabis pioneers to expand their global footprints in a meaningful way. However, until that watershed event begins to unfold in earnest, investors may want to take a rather measured approach with Canadian pot stocks in general, despite their awe-inspiring growth potential.
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George Budwell has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.
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