Could Marijuana Stocks Be Hurt By The US - China Trade War?

The writing would appear to be on the wall: A recession may be coming.

Earlier this week, researchers at Goldman Sachs lowered their forecasts for fourth-quarter U.S. GDP growth by 20 basis points to 1.8%, while economists at Bank of America/Merrill Lynch announced the odds of a recession hitting the U.S. economy within the next 12 months at 1-in-3. Though all Wall Street firms have certain metrics they eye to offer clues on the health of the U.S. economy and the path the stock market may take, there's clear worry that the U.S.-China trade war is bad news for both economies.

The U.S.-China trade war is picking up steam

The trade war between China and the U.S. has escalated and abated on numerous occasions over the past year, with the overall consensus being that neither side is anywhere close to a long-term solution. President Trump wants to narrow the trade deficit that the U.S. continually runs with the No. 2 country in the world by GDP, whereas Chinese President Xi Jinping is none too eager to give up the competitive advantages that make China such an attractive market to import from. The result has been both parties resorting to tactics that could curb domestic and global growth.

In the U.S., Trump recently announced plans to impose a 10% tariff on $300 billion worth of Chinese goods, beginning Sept. 1. Trump followed this threat up with the possibility of imposing higher tariffs, perhaps even above 25%, on these goods if progress isn't made on the trade front between both countries.

Meanwhile, China has been hitting the U.S. where it hurts by modestly devaluing its currency, the yuan. With China's government pegging its currency to a decade-low relative to the U.S. dollar, it's making Chinese goods that much more attractive to foreign companies.

In the U.S., we've seen a number of brand-name companies take it on the chin as the result of tariffs. Whirlpool, the largest appliance maker in North America, had no choice but to pass along price hikes to consumers as it dealt with higher costs for aluminum and steel. Also, tech kingpin Apple has dual concerns, with its parts supply chain set to be hit with Trump's newly announced tariffs, and its distribution in China facing the possibility of higher costs for its iPhone.

Marijuana stocks could be clobbered by an escalating trade war

Yet, technology companies and appliance makers aren't the only industries set to feel the pinch if President's Trump and Xi can't find common ground. Surprisingly, it's the cannabis industry that could get burned if new tariffs go into effect.

On the surface, a trade war probably doesn't seem like a big deal. After all, marijuana is illegal at the federal level, meaning what's grown within a legalized state has to stay within that state. And cannabis is certainly not being imported or exported from the U.S. to China.

The issue arises when examining the things needed to make the U.S. cannabis industry tick, such as lighting and lighting equipment for growers that might be produced in China, or ventilation and extraction systems that could be manufactured in China or contain Chinese steel or aluminum.

Being exposed to the possibility of tariffs certainly doesn't make the U.S. marijuana industry unique. I'd surmise that most major industries are set to face some form of higher costs if Trump's proposed tariffs are implemented in two weeks' time. The real issue, though, is that most other industries are time-tested, whereas legal cannabis is not. The marijuana industry is still in the process of finding its feet and pushing toward profitability, all while contending with supply issues and a resilient black market. The addition of tariff costs added to the equation could weigh down margins at a time when investors are beginning to lose their tolerance (and patience) for high pot stock valuations.

These pot stocks are the likeliest to be hit by tariffs

Though steel and aluminum tariffs could impact extraction and ventilation systems, the two most prominent impacts from tariffs for the marijuana industry are liable to be in lighting and vaporizers.

The marijuana industry has traditionally used high-pressure sodium (HPS) lights to grow cannabis, because of their highly predictable yield. In recent years, though, we've begun to see a push toward LED lights, which use less electricity and create less heat, albeit they have higher upfront costs. Many of the lights, be they HPS or LED, that the U.S. marijuana industry uses will be imported from China.

More specifically, this looks to be a concern for ancillary pot players Cree (NASDAQ:CREE) and Scotts Miracle-Gro (NYSE:SMG) . Cree has a factory in China that it leans on for LED production, while Scotts Miracle-Gro's acquisition of Sunlight Supply last year gives it direct exposure to China, since much of Sunlight Supply's lighting products are made in China and rebranded on U.S. soil. It should be noted, though, that Sunlight Supply represents a relatively small percentage of total sales for Scotts Miracle-Gro, whereas Cree is pretty reliant on its LED production facility in China.

The other concern would be tariffs associated with vaporizers and vape accessories. Vaping is projected to be the leading derivative consumption option in Canada, and is one of the most popular in the United States. This puts Greenlane Holdings (NASDAQ:GNLN) and KushCo Holdings (OTC:KSHB) squarely in the crosshairs of the U.S.-China trade war.

Greenlane is a cannabis accessories giant, with access to more than 11,000 retail doors throughout North America, whereas KushCo currently generates the bulk of its sales from vaporizers. If tariffs go into effect, these companies will have to decide whether their customers will pay more, or if they're going to eat these higher costs. For what it's worth, KushCo ate these costs for a while, hurting its margins, but ultimately decided to pass along the higher cost of tariffs to consumers. If Trump's tariffs goes into effect, Greenlane has been clear that its business could be adversely impacted, and my suspicion is KushCo could be in the same boat.

Only time will tell if the marijuana industry gets burned by this trade war.

Sean Williams owns shares of Bank of America and KushCo Holdings. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool recommends KushCo Holdings. The Motley Fool has a disclosure policy. This article originally appeared in the Motley Fool.