Here's Why Marijuana Stocks Got Crushed Today

Attorney General Jeff Sessions is no friend to the pro-marijuana movement, and earlier today he solidified his opposition to the herb by rolling back Obama-era guidance to ease enforcement of federal marijuana laws in states where marijuana has been legalized.

Sessions decision sent shockwaves throughout the industry, causing a sharp sell-off in marijuana stocks. Among the stocks hit hardest were Aphria Inc. (NASDAQOTH: APHQF), a Canadian marijuana company that's investing in medical marijuana in Florida. Its shares finished the trading day down more than 13%.

Marijuana companies that aren't even impacted directly by Sessions' decision fell, too. Canopy Growth (NASDAQOTH: TWMJF), which is purposefully avoiding the U.S. market until federal marijuana laws are repealed, declined almost 10%, and Insys Therapeutics (NASDAQ: INSY), which is working on marijuana drugs that it hopes will be FDA approved, tumbled more than 26%.

What's going on?

Pro-pot momentum has increased considerably over the past decade and according to Gallup polls, more Americans favor legalizing marijuana than ever before.

In response to shifting public opinions, 29 states have passed laws legalizing marijuana in one form or another, including eight states that have passed recreational marijuana laws. The biggest of those states, California, opened its recreational marijuana market on Jan. 1, clearing the way to what GreenWave Advisors estimates will become an $8 billion market.

Because legal marijuana markets are heavily taxed, states increasingly use marijuana legalization as an important source of new tax revenue. In Colorado, where recreational marijuana has been regulated since 2014, the government has already collected over $500 million in taxes. The tax revenue associated with legalizing marijuana in California could someday eclipse $1 billion.

Although many states are embracing marijuana, it remains illegal at the federal level and its classified by the Drug Enforcement Agency (DEA) as a Schedule 1 narcotic that's as risky as heroin.

Until now, federal law enforcement has turned a blind eye toward states passing recreational laws. That's in part because of an August 2013 memorandum from then Deputy Attorney General James Cole. In his memorandum, Cole shifted attention away from individuals and companies legally participating in pro-pot states, and toward prosecuting behaviors that remained illegal, such as interstate trafficking and distributing marijuana to children.

Cole's memorandum, which you can read in full, doesn't do away with the federal authority to prosecute marijuana violators in states that have legalized it, but it pretty clearly spells out that the view from the top was that enforcement within states should mostly be left up to state and local authorities, not the U.S. government.

On the surface, Sessions' decision to roll back Cole's guidance doesn't change anything materially. The federal government could always intervene under Cole's memorandum, however, it does increase uncertainty for emerging marijuana businesses that are already struggling to secure adequate financing and access to banking services governed under federal laws.

What's the takeaway?

In July 2017, Aphria announced it would be investing in a third-party company that would manage medical marijuana production and distribution in Florida. That investment, however, is tiny compared to the market opportunity that exists for Aphria in Canada, where medical marijuana is legal nationally and recreational laws are set to be in place in July 2018.

The Canadian market could double in the coming year, according to comments from Canopy Growth's CEO Bruce Linton, and his company is even more insulated than Aphria against Sessions. Rather than risk a U.S. federal crackdown, Canopy Growth -- the largest pure-play marijuana company in Canada -- has concentrated on markets elsewhere, including Germany.

Similarly, the impact of Sessions action on drug companies including GW Pharmaceuticals (NASDAQ: GWPH) and Insys Therapeutics is limited. Both GW Pharma and Insys Therapeutics are developing marijuana medicines based on marijuana cannabinoids. GW Pharmaceuticals, for example, is awaiting FDA approval of Epidiolex, a cannabidiol drug for use in specific and rare forms of epilepsy. Insys Therapeutics already has FDA approval and DEA scheduling for Syndros, its liquid formulation of the long-used THC-based drug, Marinol. Companies that secure FDA approval for marijuana drugs, and patients who use these drugs under the direction of a doctor, wouldn't be in federal cross-hairs.

The stocks that this shift in guidance does impact, however, are high-risk penny stocks that rely solely on U.S. marijuana markets for revenue. Penny stocks don't trade on the major market exchanges, and historically they're more prone to fraud. As a result, they're unsuitable investments for most investors anyway.

Overall, it remains to be seen whether any state attorney generals will crackdown on marijuana activity following Sessions decision, but it may not matter. For pro-marijuana advocates and marijuana investors, the hope has been for a friendlier federal government, and, it seems that remains unlikely, at least under this administration.

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Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.