By David Traylor
In 2019, warning signs have been intermittently flashing red for a potential economic downturn. The indicators, which include forecasted lower GDP numbers in China, falling U.S. Manufacturing PMI, some slowing economies around the world and ongoing Brexit uncertainty, are some of the issues giving investors concern. Cannabis investors should monitor the potential for a recession or downturn, since the newly-formed industry has never seen a bad economic environment.
Whether it happens this year or in the next twenty-four months or later, a recession is on the horizon. The last 10 years have been an unusually long stretch of growth and stability in the markets. By historical measures, this can’t last. The truth is, it’s hard to predict a recession in one country much less a global recession. What we can do is proactively understand the ramifications of a recession on cannabis, so that when a downturn comes, investors and founders are prepared.
Cannabis and Biotech: a useful comparison
Some industries are more recession proof than others. Healthcare, pharmaceuticals, food staples, utilities and feel-good products like cosmetics, cigarettes and alcohol are largely unaffected when the economy goes south. Since we have no historical recession data on the cannabis sector, a good place to review the past and predict the future is by looking at the biotech industry.
Biotech and cannabis are analogous based on three core factors: product development depends upon a biological supply chain, both sectors are highly regulated (marijuana is a DEA Schedule I drug) and when it comes down to it, marijuana is a drug. The modern biotech industry dates back to the 1970s; since then the sector has gone through four recessions.
The 2008-2009 recession was especially brutal: many investors lost 50% or more of the value of their portfolio. During and after the Great Recession, many of the angel investors at the time were not interested in taking on risky investments. As a result, they deserted biotech investments due to the risky nature of biotech companies, with their long development cycles, FDA barriers and massive capital needs. Investors eventually came back to biotech but only after months had passed and the economy had stabilized substantially.
Right now, cannabis is also seen as a higher risk investment and along those lines, may suffer similar outcomes as biotech did during the last major recession. Lack of national regulation for marijuana remains a problem for investors, although it’s been a great step in the right direction with the 2018 U.S. Farm Bill which made hemp legal nationwide. The FDA’s ongoing oversight of marijuana is another barrier for investors. Here’s what I think will play out from both the investor and company perspective in cannabis.
Stocks don’t lose as much as the market but investors are slow to return
There are obvious reasons why using biotech as a comparator to cannabis is relevant, as both the marijuana and hemp sectors continue to expand the use of biotechnology. More interestingly, the sector’s market performance and its evolution over time might be informative for the future performance of cannabis stocks.
In the early years of the industry in the late 1970s and early 1980s, when Genentech went public in 1978, biotech public stocks were somewhat insulated from market swings. In the first 15 years of the sector, predominantly biotech stocks didn’t whipsaw with the market. This was mainly due to the industry’s dependence on unique factors, technology evolution and individual company successes in clinical trials, not broader economic factors such as consumer spending or fiscal or monetary policy. As a result, in the 1980-82 recession, biotech stocks didn’t trend downward with the overall market.
During the Great Recession of 2008-2009, however, things changed. The stock market was in a bear market, which began in 2007. Investors, shocked by losing large amounts of value, very slowly returned to the market including the biotech sector which by that point was a mature industry.
During the next downturn, my take is that cannabis will follow a similar path as biotech did in 2009. Cannabis stocks won’t lose as much value as the broader market, but investors in both private and public cannabis companies will be cautious to return to the sector as with other high-risk sectors.
Prices and revenues will be relatively unaffected
Yet, we can’t make an apples-to-apples comparison of cannabis with biotech. Consumer spending comprises two-thirds of our economy, and consumers are the primary buyer of cannabis products, whether these are hemp textiles and lotions, medical marijuana products or recreational marijuana. We can look at recreational marijuana as a staple akin to the alcoholic beverage industry. It’s one of the last discretionary areas in a budget that people will cut when spending is tight.
On the same vein, medical marijuana products are being used to treat aches and pains as well as more serious conditions such as epilepsy, chronic pain and anxiety. Those products which improve quality of life and reduce the unpleasant symptoms of disease or injury will endure even when the economy suffers, similar to healthcare.
Looking ahead, there are a few ways that both investors and company executives can plan for an uncertain market. Here’s my take:
- Investors: Your cannabis portfolio might not be as susceptible to a downturn because it’s not as dependent on market drivers as other sectors. After the downturn, our analysis predicts a delayed return of investors into the cannabis sector.
- Entrepreneurs and executives: We don’t see major downward revenue effects for operators in the next recession. We think the recession-proof nature of healthcare and liquor will replicate in cannabis spending.
It’s an interesting exercise to consider how cannabis stocks and products will cope in the next recession, as cannabis has never had to endure one. Our analysis points to a mixed result for cannabis stocks; they won’t lose as much value but return investors and an upward move in their values may take longer. Consider your portfolio for strength of management, branding and consumer demand to balance your risk.