Pardoning an Industry

Something happened last week that sparked an explosion under a group of stocks in a widely beat down sector of the market. Single day rallies of 43%, 48%, and even 51%…

Those kinds of moves would be noteworthy in any market environment — but given today’s big bad bear market they were, although largely unnoticed, huge.

What industry got so excited in the midst of today’s economic turmoil? I’ll give you a hint…

It’s legal in 46 states but illegal in the United States of America…

I’m talking about pot. And for a brief, shining moment last week, stocks in the cannabis industry got a big, exciting boost.

Today, marijuana is legal for recreational or medical use in 39 states. Seven more states allow its use in CBD form. (Four holdout states — Idaho, Wyoming, Kansas and South Carolina — still classify it as illegal.)

But for as widely accepted as the idea of recreational marijuana is nationwide (67% of Americans believe pot should be made legal according to Pew Research) it’s still illegal at the federal level

So why does that matter? Shouldn’t the fact that cannabis is legal (to at least some degree) in so many states matter more?

The Federal Government Strikes Again

Nope…

The problem is, cannabis is what’s known as a “Schedule 1” controlled substance where the federal government is concerned.

The US Drug Enforcement Agency defines Schedule 1 controlled substances as those that the DEA believes to have “no currently accepted medical use and a high potential for abuse.”

According to the feds, this puts pot right up there with the likes of heroin, LSD (another misplaced Schedule 1 drug, but that’s a conversation for another time), ecstasy and fentanyl.

And that federal designation causes all kinds of problems where the business of pot goes. For instance…

Internal Revenue Code Section 280E denies deductions and credits for amounts paid or incurred in carrying on the trade or business of trafficking controlled substances. Since cannabis is a federally controlled substance, state-legal cannabis businesses cannot deduct business expenses the way a traditional business can.

Neither can they take advantage of typical business banking services… 

Marijuana is illegal at the federal level. And federal banking laws prohibit criminal drug money laundering. This means that even in states where cannabis is legal, banks run the risk of violating these federal laws if they process credit card transactions or accept deposits from the businesses.

That means no bank loans, no checking accounts, no credit card merchant accounts, no regular tax deductions even for the legal cannabis business. Colorado State Representative Dan Pabon noted: 

“There are businesses creating millions of dollars in revenue and paying taxes with bags of cash.”

Kind of ironic for a government with such a compulsive bent for regulation!

This status not only prohibits them from getting banking services, but it also prevents serious investment capital from finding its way to them…

…all plant-touching U.S-based cannabis companies are forced to trade on the “pink sheets” (or on the Canadian Securities Exchange) which means many institutions are forbidden from buying them. As odd as it may be, many institutions and hedge funds are prohibited from buying stocks that don’t trade on a senior exchange (like the NASDAQ or NYSE). And until cannabis is federally legal in the US, any company that touches the plant, thereby breaking federal law, is forbidden from listing on the NASDAQ or NYSE.

And you might think the G would take some action to unsnarl the legal situation because it’s now been proven…

There’s Big Money in the Pot Business!

California was the first state to legalize marijuana for medical purposes all the way back in 1996. Nineteen more states followed suit over the years. But it wasn’t until 2012, when Colorado and Washington State legalized it for recreational purposes, that the financial potential of selling legalized pot became apparent. 

Governments in the US have generally never met a tax they don’t like. And taxes on all our “sins” — alcohol, tobacco, etc — are some of the most popular.

The pot business turned out to be a bonanza!

According to the Tax Foundation, in 2020, Nevada generated $105 million in pot-related tax revenue… Colorado earned $307 million…  and California, the granddaddy of progressive pot laws, took in $474 million. 

Even the Kansas City Fed even chimed in.

In a special economic bulletin they noted:

…Colorado and Washington State took in more revenue from marijuana sales than from either alcohol or cigarettes in Fiscal Year 2022.

Federal tax estimates from the Tax Foundation going back to 2016 suggested:

A federal tax of $23 per pound of product, similar to the federal tax on tobacco, could generate $500 million per year. Alternatively, a 10 percent sales surtax could generate $5.3 billion per year, with higher tax rates collecting proportionately more.

So you’ve got pretty much a cash cow that no legitimate business can (or is willing to) touch…

Could President Biden Be the Pot Industry’s Hero?

Let’s go back to last week for a second.

Last week, on October 6, President Biden signed a proclamation that pardoned “all current United States citizens and lawful permanent residents who committed the offense of simple possession of marijuana in violation of the Controlled Substances Act.”

Pot stocks erupted on the news…

Curaleaf Holdings Inc (CURLF)

Source: Barchart.com

Trulieve Cannabis Corp. (TCNNF)

Source: Barchart.com

Green Thumb Industries Inc. (GTBIF)

Source: Barchart.com

It’s worth noting that, by the White House’s own admission, there are currently ZERO federal inmates who are incarcerated solely for simple marijuana possession. So this whole exercise could be little more than an election year stunt. (That said, it’s hard to ignore the market’s impressive reaction to even the slightest positive news on the marijuana front.)

It’s also worth noting that the president called on governors to pardon STATE inmates who are incarcerated for simple pot possession — of which there are a few more. 

But even more interesting was the third point the president made: 

“We classify marijuana at the same level as heroin—and more serious than fentanyl. It makes no sense,” Biden asserted, adding that he’s asking U.S. Health and Human Services Secretary Xavier Becerra and Attorney General Merrick Garland “to initiate the process of reviewing how marijuana is scheduled under federal law.”

Now, “Initiating a process of reviewing…” is Washington-speak and one small step removed from “Considering thinking about discussing…” Which means pretty much nothing.

And Joe Biden himself has never expressed an interest in fully legalizing cannabis at the federal level. 

But moving marijuana off the Schedule 1controlled substance list would revamp the landscape for the cannabis industry in a HUGE way.  

An action of that magnitude, would likely take years to get done. However, more recently there have been other promising developments in the works.  

While not advocating directly for federal reforms, that same report by the Kansas City Fed suggested, “the state markets could be empowered by congressional action to provide marijuana businesses with access to the banking system.

Congress seems to have taken that idea to heart. In July of this year, the House of Representatives took action to pass legislation called the SAFE Banking Act. (The act is part of a larger piece of legislation called the “States Act” which would allow broader acceptance of states’ cannabis laws at the federal level.)

In a nutshell…

The SAFE Banking Act aims to protect banking institutions—as well as their insurers—that choose to offer services to legitimate cannabis-related businesses operating in accordance with their respective state laws. The bill prevents federal banking regulators from imposing penalties on depository institutions that offer services to cannabis-related businesses. If enacted, transactions involving activities with a legitimate cannabis-related business would no longer be considered as generating proceeds from unlawful activities, and depository institutions would no longer be liable or subject to any federal law or regulation for providing services to the cannabis industry.

This law still needs to get through the Senate.

What Can We Make of All This?

All that said, we’re still in a terrible economy. The Fed is cranking up interest rates to control rampaging inflation. And that is effectively pushing the economy toward the inevitable recession (if we’re not there already). 

And pot stocks, while attractively valued, are still very speculative and — like everything else — have been taking a beating. 

The cannabis-related stocks we’re holding in the Streetlight Confidential Portfolio — the AdvisorShares Pure US Cannabis ETF (MSOS) and Juva Life Inc. (JUVAF) — are no exception.

But remember, investing is a long term game. And things appear to have started to move in this particular area.

There’s a cynical part of me that says the House may have passed the SAFE Banking Act knowing full well there’s no chance of it passing the Senate. (Congress can’t piss off their Alcohol and Pharma lobbyists too much). 

Still we can’t ignore what’s happening.

And if pardoning exactly “zero” federal cannabis prisoners can create that kind of reaction in the market, imagine what would happen if some real legislation actually got passed …

It could be a whole new landscape for the cannabis industry — even in this economy.

I’ll keep you posted…

Full Disclosure: I own shares of AdvisorShares Pure US Cannabis ETF, Curaleaf and Trulieve.

Make the trend your friend,

Bob Byrne 
Editor, Streetlight Confidential