One of the reasons many U.S. marijuana stocks are undervalued right now is that they can't reach a broad pool of investors. The federal ban on marijuana prevents them from trading on major exchanges like the Nasdaq or the New York Stock Exchange (NYSE). Marijuana companies in the U.S. also struggle to obtain funding as many banks shun them out of fear of facing repercussions from the federal government.
And despite there being optimism that legalization may be around the corner, that's by no means a guarantee as the industry might still have a long road ahead of it, especially in light of the recent actions made by top bank JPMorgan Chase (JPM 0.15%).
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Bank to restrict the trading of marijuana stocks that operate in the U.S.
According to Reuters, JPMorgan "has told prime brokerage clients it will no longer let them buy certain U.S. cannabis-related securities beginning Nov. 8." This relates to companies with a "direct nexus to marijuana-related activities" that do not trade on one of the main North American exchanges, such as the Nasdaq, NYSE, or the Toronto Stock Exchange (TSX). Those primarily affected by this decision are multi-state operators such as Curaleaf Holdings (CURLF 4.67%) and Trulieve Cannabis (TCNNF 1.41%), which because of the illegality of cannabis in the U.S., have to trade over the counter and on the Canadian Securities Exchange, which has laxer rules than the TSX.
The bank will allow clients to liquidate their positions in such holdings, but they won't be allowed to make new purchases or take on new short positions in them. As a result, there could be lots of selling activity this week of those pot stocks from panicked investors. That doesn't mean it's impossible to buy the stocks as there are other brokerages out there, but this is yet another example of how investing in the U.S. cannabis industry continues to be a challenge.
Why did JPMorgan do this?
While nothing specific has changed in the marijuana industry to suggest these types of stocks have gotten riskier, the bank told its clients that it has a new "framework that is designed to comply with U.S. money laundering laws and regulations by restricting certain activities."
Banks that deal with marijuana companies have to fill out suspicious-activity reports on a recurring basis. And although it isn't impossible for a company to open a bank account or even obtain a loan, it's certainly not easy. A top bank like JPMorgan is going to be especially wary of being involved with the industry.
Nonetheless, it's an interesting development considering that there appears to be hope for marijuana reform, with Senate Majority Leader Chuck Schumer pushing for marijuana legalization and President Joe Biden appearing to be in favor of decriminalizing the substance. It may not necessarily mean that the bank believes reform is a long shot. It could just be the bank's own risk management team that decided to take these additional precautionary measures to ensure they don't run afoul with the federal government.
Should cannabis investors be worried?
There's no doubt that this development could be concerning, as it has the potential to negatively impact liquidity in marijuana stocks. A reduction in liquidity can lead to volatile price movements, and thus, more risk in the short term.
For long-term investors, however, this is just a bump in the road. With 36 states permitting medical marijuana and 18 of them having enacted legislation for adult-use pot, the writing is on the wall that legalization, or at least some kind of reform, will likely be coming soon. Fewer than 10% of Americans believe marijuana should remain illegal.
This week (and possibly for the foreseeable future) there could be some adverse price movement for Curaleaf and other MSOs, but that shouldn't deter investors from owning these stocks. The top marijuana companies in the U.S. are building out their positions in the country (Curaleaf is in 23 states) and will be among the biggest winners once marijuana reform eventually takes place. With an annual revenue run rate of more than $1 billion, Curaleaf is already a top company in the industry. As marijuana laws loosen up, it could set up the business for even better results. Legalization, for example, would allow the company to ship its products across state lines and benefit from economies of scale.
It'll require patience, but holding on to shares of U.S.-based marijuana stocks could lead to some significant returns over the long run.
