Beware of Getting High on Marijuana Stocks

NEW YORK (TheStreet) -- If you need proof that we are entering the mania stage of the stock market cycle, look no further than the action in marijuana-related stocks this year.

I know what you're thinking. What serious investor would actually be writing about these stocks?

This is not about the stocks themselves, though, but what growing investor interest in these companies is telling us about overall market sentiment.

In the early stages of a bull market, investors who capitulated during the prior bear market will start to wade back in, usually with high-dividend or defensive stocks. As the bull market progresses and investors become more confident, new entrants are more likely to seek out stocks that are more economically sensitive, such as small caps or cyclicals.

In the latter stages of a bull market, new entrants who missed much of the prior rally will inevitably chase whatever has the most extreme recent performance. That is the only way these investors can attempt to catch up to the enormous gains they have grown tired of hearing about from friends and relatives.

We are likely entering that stage. With the S&P 500 up over 170% during the past five years, investing in a consumer-staple stock such as Coca-Cola (KO) or Johnson & Johnson  (JNJ) isn't going to cut it if your objective is to double your money in a short period of time. You need something with extremely high volatility and a compelling growth story; earnings and cash flow are optional.

Enter the marijuana industry. With growing legalization for medical purposes across the country and the passage of laws in Colorado and Washington that allow marijuana for recreational use, the growth narrative is in place.

Naturally, investors are looking for ways to capitalize on this growth and have bid up a number of companies related to the industry with colorful ticker symbols. Some of the companies are Growlife (PHOT), Hemp Inc. (HEMP), Cannibis Science (CBIS) and Medical Marijuana (MJNA).

Interest in these stocks is growing exponentially as evidenced by the recent spike in Google searches for the term "marijuana stocks" (see graph below).

What we are witnessing here a classic example of market psychology where momentum and the greater fool theory outweighs everything else. You simply buy a stock because it has gone up the most in a short period of time, hoping to sell to someone else (the greater fool) at a higher price. There are a handful of stocks in the industry that are up anywhere from 100-900% this year (see chart below).

How will this all end? I really have no idea. One of these companies may actually go on to make a profit and grow into the high expectations set by investors. History has shown us, however, that the market is rarely kind to this type of late-cycle speculation. In hindsight, we may look back at this wild speculation as a warning sign of an impending market top.

Overall, most investors would do well to ignore the allure of these types of extreme, short-term price gains and stick to their long-term, diversified asset allocation plan. That may not be as exciting as gambling on the latest fad, but excitement and investment success seldom go hand in hand.

At the time of publication, the author had no positions in the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.


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