This has been a big month for marijuana stocks. It began on election night, with the U.S. producing a green sweep. Five states had cannabis initiatives or amendments on their ballots for vote, and every single weed measure passed. Since California paved the way in 1996 as the first state to legalize medical marijuana, we've now witnessed 35 additional states follow suit. Of these 36 legalized medical weed states, 15 also allow recreational consumption and/or sale.
Although it took a couple of extra days, we also witnessed Democratic Party challenger Joe Biden win the presidential race. This is noteworthy considering that Democrats have a much more favorable view of cannabis than Republicans -- and it has the investment community excited.
Canadian pot stocks soar following U.S. election results
Interestingly enough, it wasn't U.S. pot stocks that staged the biggest rally following the U.S. election. Rather, it was Canadian licensed producers (LPs) that've been blazing hot. In the three-day stretch following election night, here are some of the returns for Canada's best-known producers:
- Aurora Cannabis (NASDAQ:ACB): up 99%
- Canopy Growth: up 15%
- Tilray: up 45%
- HEXO (NASDAQ:HEXO): up 40%
- OrganiGram Holdings: up 23%
- Cronos Group: up 24%
These gains imply there's growing hope that the Biden administration will lead to the federal legalization of marijuana in the United States. Canadian LPs like Canopy Growth have pledged not to enter the U.S. until the federal government changes its stance on cannabis. Additionally, these companies would risk losing their U.S. listing status by engaging in the cannabis industry while it's still federally illegal.
As some of you might recall, Vice President-Elect Kamala Harris was among a growing number of Democratic presidential candidates during the primary process who voiced clear support for federal marijuana legalization. Investors might be of the opinion that the incoming Vice President can sway policy toward legalization.
And, when in doubt, there's always public opinion. In 2018 and 2019, national pollster Gallup found record-tying support (66% of survey-takers) for the nationwide legalization of pot.
The blunt truth about cannabis under the Biden administration
But what if I told you this hope was nothing more than an investor pipe dream?
President-Elect Joe Biden has been vocal about his past views on marijuana, but has stopped short of calling for legalization on numerous occasions. Instead, Biden would prefer to decriminalize weed in the U.S. and reschedule it. Currently, it's classified as a Schedule I substance, meaning it has no recognized medical benefits and is wholly illicit. Biden's proposal would move marijuana one rung lower on the controlled substances ladder (Schedule II). It would have recognized medical benefits at this classification, but also be considered prone to abuse.
This might sound like a "fix," but it's not.
For starters, Schedule I and II substances are subject to Section 280E of the tax code. Implemented in 1982, 280E disallows businesses that sell federally illicit substances from taking normal corporate tax deductions, save for cost of goods sold. As a result, profitable businesses that sell Schedule I and II substances often pay very high effective tax rates.
The potentially scarier problem for the cannabis industry is that Schedule II substances would fall under the critical eye of the U.S. Food and Drug Administration (FDA). The FDA would have the ability to control how pot businesses market and label their products, and is likely to oversee the manufacturing process for cannabis.
More specifically, the FDA could also require that clinical trials be run to validate claims that marijuana helps with specific ailments. This would throw a gigantic monkey wrench into the medical cannabis industry and could actually hamper progress.
A divided Congress would create cannabis gridlock
But wait -- there's more.
Aside from Biden's cannabis proposal almost certainly failing to make things better for the U.S. cannabis industry, there's a strong likelihood that the president-elect will be working with a split Congress. Democrats will maintain a small majority in the House of Representatives, while a January runoff for two Senate seats in Georgia will determine the political make-up of the Senate. Republicans only need to win one of those two remaining seats to maintain control off the upper house of Congress.
The reason this is important is because Senate Majority Leader Mitch McConnell (R-Ky.) has a long track record of blocking cannabis reform measures and ensuring they don't make it to the Senate floor for vote. Assuming the GOP retains control of the Senate and McConnell reprises his role as Senate Majority Leader, there'll be almost no opportunity to legalize pot at the federal level or even pass cannabis banking reform.
In other words, the hoopla among Canadian pot stocks makes little sense. While it's true that the Joe Biden has a modestly more favorable stance on weed than sitting President Donald Trump, there's still not a path to legalization, and therefore no clear path for Canadian LPs to enter the United States.
This should serve as a clear warning to investors who've been blindly piling into names like Aurora Cannabis and HEXO in the past couple of days. Aurora Cannabis has been diluting its shareholders to raise capital for years, whereas HEXO is facing a 1-for-8 reverse stock split next month just to avoid being delisted from the New York Stock Exchange.
There's no question the U.S. is going to be the most lucrative marijuana market in the world. But if you want to invest in pot stocks, stick with companies already based in the United States. They may not be listed on a major U.S. exchange, but they're far better suited for long-term success.