A market correction is coming. Canada’s commercial cannabis producers are not atypical. They will not be exempt. Their market highs are going up in smoke.
One way to demonstrate this fact is through the Cyclically Adjusted Price-to-Earnings ratio or “CAPE” for short. This ratio refers to how much one is willing to pay for shares of a company, relative to the company’s long-term average earnings.
In other words, it helps investors assess whether the market is under or overvalued. What makes CAPE unique is that it assesses a company’s long-term profitability with the business cycle in mind.
The business cycle is the supposed “natural” fluctuation of capitalism. A time of economic boom followed by busts. Prosperity followed by recession. Profits followed by losses, even bankruptcy.
We have CAPE data going back to the 19th century. While not a perfect metric, it nevertheless reveals a glimpse of the underlying economic reality.
When the ratio is 15 times the average, it’s considered excessive.
We’re at 33. [For more information, click here]
A company typically has long-term average earnings. In this market, investors are saying, “never mind that now, we’ll gladly pay more than twice as much as its worth.”
Like being offered schwag at premium prices. And actually buying it.
Why are investors doing this? Are they crazy? What is going on?
Markets rise and organize around price signals. A discovery made only through actual exchanges. In capital-intensive economies, rates of interest are especially important. They communicate information over time.
Typically, when interest rates are low, it’s because a lot of people have deposited their savings in their bank account.
Banks engage in fractional reserve banking, loaning out those savings to entrepreneurs, investors, businesses, etc.
With sufficient savings to draw from, banks charge little in interest. Whether one is depositing money or looking to borrow.
A low-interest rate allows entrepreneurs to borrow for long-term projects. Ideas that simply can’t be executed when interest rates are high.
Typically, when interest rates are high, it’s because people are consuming in the immediate present. Bank capital is low and so they offer high-interest savings accounts to attract depositors.
High-interest rates are a disincentive for businesses embarking on long-term projects, since, in reality, the resources aren’t available to complete them.
This is the “Austrian” theory of the business cycle. I call it the science of scarcity. Mainstream economics is pseudoscience- data and models used to justify the Empire.
When interest rates are free to adjust according to the valuations of individuals in a free market, there is no business cycle. Bank runs, yes. But a bank is only as powerful as the legislation behind it.
And Canada’s cannabis giants are only as powerful as the stock market behind them.
A stock market built on artificially low-interest rates. A period where people consume while entrepreneurs and investors act as if people are saving. Eventually, the lack of resources becomes apparent. Enter, the recession.
Canada’s central bank, like its American counterpart, is responsible. They credit the accounts of the private banks on Bay Street and Wall Street. This solves the problem of having to attract customer’s deposits to make loans.
But this credit is created out of thin air. It doesn’t come from any previous savings or capital accumulation on the part of the central bank. The central bank doesn’t debit itself.
This is creating money out of thin air, pure and simple. This is how interest rates are price-controlled.
The process distorts the important signals interest rates communicate. This is why the market isn’t allocating resources efficiently. Creation of new money won’t create new resources. Projects started from these loans can’t possibly be completed.
When free market signals begin to override bank interference, wastefulness becomes clear as day. This is the bust period. The recession.
Are Canada’s commercial cannabis producers at risk of being one of these unfinished projects?
Is Tilray the next Pets.com?
Canada’s licensed producers expect long-term growth from global markets buying their product. From individuals saturated with rising debt, taxes, and bills.
Even for many baby-boomers, the demographic often hyped-up as the next cash-cow of the cannabis world, the idea of retirement is a joke. Do LPs expect them to maintain a steady cannabis habit on top of everything else?
Of course, smoking weed would help take the edge off working a 40-hour job well into your 70s.
If you can afford it…
Canada’s large commercial cannabis producers have exploded in the last few years. Buying up foreign assets. Expanding their scope and vision. Their stock market valuations in the billions.
But where exactly is all this long-term growth coming from?
Featured image courtesy of Stock Investor.