the AdvisorShares Pure US Cannabis ETF (NYSE: MSOS) had a slow start to 2022, but that’s not due to Dan Ahrens’ lack of purchases. Portfolio manager AdvisorShares MSOS has consistently put money to work, presumably happy enough to accumulate stocks and derivatives at what many perceive to be depressed stock values. But with price developments stagnating despite substantial ETF buying, is the MSOS crash earlier this year a harbinger of things to come? We explore this question further.

Despite 2021 performance in MSOS trailing the S&P 500 by around 5350 basis points, coppers at AdvisorShares seem unfazed. So far in 2022, approximately $65.35 million worth of underlying MSOS component shares and swap derivatives have been purchased, in a strong show of support for underlying US cannabis fundamentals. That figure includes about $14.1 million in ETF net inflows to start the year, likely from like-minded investors who also believe in the sector’s growth trajectory.

AdvisorShares Pure US Cannabis ETF Beginning and ending cash position in 2022

As a reminder, an equity-based exchange-traded fund (ETF) includes a basket of stocks to track a single industry or sector, but can be bought or sold on an exchange like a common stock. As a cannabis-focused ETF, MSOS holds a basket of industry securities through individual purchases of its underlying constituents or swaps, such as Growgeneration Corp. (stock) or Trulieve Cannabis (to exchange).

Currently, AdvisorShares MSOS relies heavily on swap derivatives to gain exposure to its core holdings, as it is unable to invest directly in many US cannabis companies due to federal and custodian bank restrictions. . Until a law to legalize cannabis at the federal level is enacted, the use of exchanges will likely continue. A total return swap is a commonly used derivative contract between two parties that exchanges cash for the return of a financial asset. AdvisorShares MSOS primarily trades cash against the performance of certain public US cannabis companies, where returns will approximate the underlying performance of the shares.

For price-focused investors considering buying the benchmark cannabis ETF, the current price pattern is somewhat unsettling. Despite approximately $65.35 million in cash deployed, or approximately 76% of the available cash balance, the MSOS still declined ↓6.09% in the first two weeks of 2022 from a decline of ↓3.88% in the S&P 500 (as of January 18). The 221 basis point difference reflects similar dynamics seen in 2021, where AdvisorShares MSOS cratered ↓29.89% despite a historic broad index bull market fueled by accommodative monetary policy. In absolute terms, this is not the start that cannabis investors were looking for.

While it’s certainly likely that the MSOS AdvisorShares could generate additional inflows in the days and weeks ahead, the below-average price action might as well keep investors on the sidelines, for now. Without additional inflows, Ahrens’ asset purchases will slow, removing a favorable anchor in the market.

From a technical point of view, the market does not appear particularly bullish either. AdvisorShares MSOS current price ($24.02/share as of Jan 18) shows the ETF is trading below all major moving averages in TradingView’s daily and weekly technical monitoring. The 7-period exponential moving average (7EMA) on the weekly chart – an indicator the author regularly uses to delineate strength (or lack thereof) in conjunction with volume – has been stuck below the 7EMA since early November. A quick look at the weekly chart shows that the MSOS is more or less tied to a declining 7EMA since March, a momentum that needs to be overcome to provide further momentum.

Continued bullish bets in the options market add to the uncertainty of the rally, which does not indicate the bearish sentiment normally seen at inflection lows. The Put/Call Open Interest Ratio on the major contracts for the months of February/March/June/September and January 2023 are all 0.20 or less currently, giving a bullish sentiment.

Traditionally, an average put-call ratio of 0.7 is generally considered the demarcation marker for bearish sentiment in equities. Often, bearish sentiment is a precursor to a major trend change, as most potential sellers have likely already sold their positions. Can we say the same for the majority of American cannabis investors?

AdvisorShares MSOS a bullish positional game for the patient

Of course, the flip side is that AdvisorShares MSOS is not a technical trade at all. Despite the lagging performance (again) and sloppy technical picture, the ETF is very much a game of compressed valuations that will definitely unlock once federal cannabis legislation is enacted. Although it’s unclear if anything is akin to SAFE Banking, Chuck Schumer preferred Cannabis Administration and Opportunities Act (CAOA), or more fundamental legislation is passed, the market is unanimous in believing that meaningful federal regulation will get things moving.

As we can see below, there is a lot of “unlocking” to do once this catalyzing event(s) has taken place.

Compared to all industries, cannabis stocks were among the cheapest asset classes based on projected 2022 results. And now they have become even cheaper compared to expected 2023 results, which will become increasingly the comparables on which the market focuses. As it stands, the average enterprise value (EV) to sales multiple is only 2.3 for 2022 compared to the forward-looking multiple of 4.1x a year ago. The popular EV/EBITDA metric currently sits around 8.0, down from 16.4x a year ago. Again, when looking at the 2023 numbers from a forward-looking perspective, multiples become even cheaper.

There is also the issue of margin compression and slowing sales, which undoubtedly affected cannabis stocks in the second half of last year. After a disappointing 2021 legislatively, the big players will use 2022 to build their presence in existing cannabis markets and adjacent industries, according to CNBC cannabis analyst Tim Seymour. He expects a targeted approach to brand building to help “insulate” publicly traded cannabis companies from margin pressures.

We could also see inflation (PPI) drop dramatically, which will positively affect the results of US cannabis companies. Although the inflation comedown thesis is far from bankable at present.

Last word

In our view, AdvisorShares MSOS remains trapped in two distinct dynamics. In terms of absolute performance (both long-term and recent), technical picture, and still bubbly sentiment, the benchmark ETF still doesn’t look like “buy.” Add the fact that Dan Ahrens threw out the kitchen sink buying the underlying MSOS stocks/derivatives to limited effect, recent price action isn’t particularly encouraging.

However, from a fundamental point of view, AdvisorShares MSOS is in a favorable position. Valuations are depressed despite strong year-on-year growth; recent factors such as margin/retail price compression could be transitory headwinds; and some federal regulatory ploys should do well in 2022. If one were to buy MSOS in a stock account today and not watch it for 3 years (maybe even until November midterms), returns are likely to impress.

So whether or not Mr. Ahrens gets additional ammo to (partially) sustain the sector, the future of MSOS looks bright. The biggest key for investors is figuring out individual timelines on pronouncements and the chances that federal legislation could take hold this year. Investing based on past price action means nothing if catalytic regulatory action takes place. However, the fundamentals may remain depressed for year while the right investment environment takes shape. The movement on the federal regulatory front in 2022 is still murky at best.

As always, opportunity is in the eye of the beholder. But we’re on the sidelines aggressive purchases until we get more information on the regulatory catalysts needed to change the momentum. We will gladly give up a few percentage points of return to avoid catching a dead money trade. At least until we hear more from the power brokers on Capitol Hill.