On November 2, California will vote on Proposition 19, a ballot measure that would legalize marijuana within the state. One frequent argument for legalization is that it will generate a fiscal windfall by reducing expenditure on marijuana arrests, prosecutions, and incarceration and by allowing the state to collect tax revenue on legalized sales.  California sorely needs this boost, since it is facing a budget shortfall of roughly $20 billion for fiscal year 2011.

How big might this windfall be? In a recent study for the Cato Institute, Kate Waldock and I conclude that California could, under some assumptions, save $960 million in expenditure and raise $352 million in tax revenue from legalized marijuana. Some of these assumptions are problematic, however.

The first issue is that our estimates examine the scenario in which all states and the federal government legalize marijuana simultaneously.  That will not happen in the short term, even if Prop 19 passes.  In particular, the federal government may try to prevent implementation of the California measure, making it difficult to collect tax revenue.

The second issue is that, whatever the federal government’s response to Prop 19, achieving the savings in criminal justice expenditure will be difficult politically because it involves laying off police, prosecutors, prison guards, and the like. So, these savings may not occur.  If these criminal justice resources are redirected to better uses, such as targeting violent crime, Californians may still benefit, but this will not show up in the state budget.

The debate about Proposition 19 should therefore focus on issues other than any budgetary impacts.  The most important consideration is that, in a free society, adults should be able to consume marijuana so long as they do not harm others.  Thus laws against driving under the influence, or minimum purchase ages, or sin taxes, are defensible at least in principle.  An outright ban on marijuana is not.

Without question, the most fascinating stock story of 2010 is the raging success of Netflix compared with the epic collapse of Blockbuster, which just this morning filed for bankruptcy.  There is a cautionary business tale in here that is both timeless and essential for all investors to understand.

The below should be recited in the meter of Lewis Carroll’s ‘The Walrus and the Carpenter’ from Through the Looking Glass:

The sun was setting on the boom
The Credit Crunch was here
And all the people in their homes
Were looking for some cheer
And in their search for things to do
A new option appeared

The move was watching DVDs
Because they were so cheap
There was one franchise renting flicks
Although it was asleep
And while it wasn’t watching out
A new one came to creep

The burning down economy
Turned jobs and lives to ash
You could not take a trip because
You didn’t have the cash
No one was eating dinner out -
We worried ‘bout the crash

The Netflix and the Blockbuster
Were at each others’ throats
They fought to show The Street they had
An economic moat
“Our strategy is still our stores”
The old incumbent wrote

“For fifteen bucks each thirty days
We let you rent it all,
Can you beat that?” the Netflix said
“With stores leased in the mall?”
“I hope so,” thought the Blockbuster
But it had hit the wall

“O renters, come and rent from us!”
The Netflix did beseech
“A pleasant site, with checkout right,
And all movies in reach;
You make your queue of films you want
And we will mail you each.”

The Blockbuster was scared by this
But never did admit
Instead they built a website too
But no one would use it
Needless to say the management
Was not prepared to quit

The Netflix and the Blockbuster
Fought on a year or so
And then the country froze in shock
While business quickly slowed
And all the newly jobless went
Online to rent a show

“The time has come,” the Netflix said,
“To talk of many things:
Of discs and flicks and digital -
Of downloading these things -
And how we stream this stuff to you
Before the mailman brings.”

“But wait a bit,” said Blockbuster
“We can do all that too,
Just let us close some stores real quick,
Don’t hate Yellow and Blue!”
But nothing worked for Blockbuster
They couldn’t buy a clue

“A bold new plan,” said the top man,
“Is what we chiefly need:
Bricks and clicks and mail besides
Are very good indeed—
Now if you’re ready, customers
Come to the stores and see it!”

But Netflix had already grabbed
The rental market whole
And without stores or overhead
There was no costly toll
“The game is won,” the Netflix said
“We’re really on a roll.”

Blockbuster ran the industry,
Until 2004
Its customers have moved online
And bankrupted the store
While Netflix stock has broken out
Above One Fifty Four!

So there you have it.  It’s a story that’s been told a million times: the complacent giant felled by a nimbler, hungrier upstart with new ideas.

My apologies to Mr. Carroll.  Here’s the saga of these two competitors in chart form over the last two years:

Mark Twain tells us that history doesn’t repeat itself, it rhymes.  When it comes to investor behavior going into earnings season, I beg to differ — it is repeating itself even now.

There is a pattern in place that you may want to familiarize yourself with as history has just repeated itself six quarters in a row.  The pattern has been a run up in stocks at the beginning of earnings season’s opening month followed by the almost inevitable denouement as hearts are broken and focus is diverted elsewhere.

In each of the last six quarters, the Dow Jones was up on average seven of the first 10 days of the first reporting month (January, April, July, October).  Each of these rallies ended up succumbing to selling, even during quarters with high-percentage beat rates.  This action is both a commentary on our Twitter-addled attention spans and a classic embodiment of a Wall Street law so old that Hammurabi himself may have written it: Buy on the rumor, sell on the news.

For a reference point, take a look at last quarter’s earnings season (above) which kicked off with a bang in early July.  All of a sudden, consumer confidence data began overshadowing anything coming from Corporate America. On July 16, we were looking at a brutal 250 point sell-off of the Dow Industrials, wiping out any enthusiasm from upbeat calls.  We would resume the rally for a time, only to give it all back as the drumbeat of reports winnowed away.

You can also look at the first quarterly earnings season of 2010 and see the same pattern.  We were rockin’ and rollin’ throughout the month of April as each headline read “better than expected”.  By early May, however, news from our European cousins began to overshadow these upbeat profit reports.  On May sixth, the euro fears had flooded over the transom and we were treated to the infamous Flash Crash.

Will this coming earnings season repeat (or even rhyme) with the last six?  We may already be on that track as stocks have begun to breakout of the much-vaunted trading range you’ve heard so much about.  The nominal reasons?  The NBER has (officially) declared us out of recession.  Money is being made again in gold names, tech takeovers and, somewhat incongruously, video rental stocks.  Plus, cosmically speaking, the rally was almost preordained from the moment Tony Robbins started recording videos about an impending crash (mid-August).

In short, there is an effervescence in the air as we head into the Q3 reporting period.

Can investors maintain this enthusiasm throughout October and roughly four weeks of crucial reports?  If not, we may be looking at yet another earnings season letdown.  Alcoa doesn’t start us off until Oct. 7, there’s a lot of room between now and then.  The Ghosts of Earnings Past are haunting the nascent rally even as you read this.

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A bombshell new survey from the Infogroup/ORC concerning what Americans believe about financial advisors and stockbrokers has the potential to turn the entire industry on its head.

We’re not talking semantics here, we’re talking about a fundamental confusion that afflicts more than two thirds of the investors in this country.  This is a landmark survey because understanding the difference between advisors and brokers should be a sine qua non for investors before entering into any financial relationship.

According to the poll, which came out on September 15, an overwhelming majority of investors do not understand the fact that stockbrokers are in the business of selling them things while advisors are in the advice business.

Let me give you the data first:

* Two out of three U.S. investors (including 70 percent of 45-54 year olds and 62 percent of college graduates) are incorrect in thinking that stockbrokers are held to a fiduciary duty.

* 76 percent of investors are wrong in believing that “financial advisors” – a term used by brokerage firms to describe their salespeople — are held to a fiduciary duty.

* By contrast, 75 percent of investors think the fiduciary standard is in place for “financial planners” and 77 percent say the same about “investment advisers.”

* Over three out of five American investors mistakenly believe that stockbrokers are investment advisers.

The survey group included around 2,000 or so people, half men and half women.  How is it possible that there is such a major misunderstanding about the difference between advisors and brokers?  I’ll explain: continue »

Here’s a composite quote that could come from the market strategist of virtually any major firm, I’m certain you’ve read something like this over the last few days:

“The stock market is nearing overhead resistance, a punch through would be a positive catalyst only if volume picks up before or during the breakout.”

- Any Chief Market Strategist, Any Firm USA

Wrong!

Price rules in this environment.  Volume is completely and totally irrelevant until about 5% to 7% after the breakout.

The breakout could come with only 60% of normal volume and be just as meaningful.  In counter-distinction to the conventional wisdom, I would argue that a low volume breakout would actually be preferable right now.  Here’s how I arrive at this idea…

Nobody is in.  Nobody.  We’ve documented the equity fund outflows ad nauseum, they are bigger than Precious after Thanksgiving dinner.  Fine.  The question becomes, what can we agree is the more motivating condition for investor psychology right at this moment, Fear or Greed?

The answer is undoubtedly Fear.  How else to explain the endless Treasury rally and the full-scale retreat from equities?  Fear is the conductor of this train right now, period, end of story.  With that in mind, I ask you to think about the one thing that American investors fear more than anything else – the fear of missing out on the big opportunity.

Nothing freaks out the average investor more than watching the train leaving the station without them.  I could put up 75 charts showing parabolic blow-off tops in various markets or I could just remind you that I’ve worked with over 1,000 individual investors over the years and I know this stuff.

Fear of missing out is exactly why a stealth rally in stocks with low participation would be more meaningful and bullish than almost any other scenario.  What could possibly draw hundreds of billions out of money markets faster than a 5% S&P rally that no one was a part of?

So please, stop regurgitating the “we need real volume” pablum, it is functionally backwards.  What we need are higher prices, the lower the participation the better.  That’s the kind of milkshake that brings all the boys to the yard, buy tickets fluttering in the breeze.

Show me a September rally on no volume and I’ll show you a pack of dogs who will chase this market higher into the winter.

Don’t get it twisted.

When they write the book about what worked in 2010, investing in the BRIC nations will probably not make the list.  Too much consternation over whether or not China has a real estate bubble has held the theme back, even though Brazil and India turned in a decent year.

What did work?  Well OMG, have you taken a look at the Frontier Market stocks of late?  Performance has been ridiculous.

Before showing you the below chart, I want to make clear that I’m using these two ETFs as exposition, these are not recommendations.  You’ll see the BNY Mellon Frontier Markets ETF ($FRN) blowing away the BNY Mellon BRIC ETF ($EEB) in the chart below:

Investing in frontier markets is still very difficult.  Owning stocks directly in Egypt or Chile or Poland is next to impossible for most individual investors.  The BNY Mellon Frontier ETF I’m referencing above is a product that owns frontier country companies, but it buys only the ones that have ADRs on legitimate exchanges like London or the NYSE.  Top holdings come from Columbia, Poland, Kazakhstan and Chile, but again, the fund owns their ADRs rather than local shares.  This ensures a bit of volume and some uniformity in accounting practices.

I’ve written extensively about my fascination with Frontier markets as an investment theme.  See my primer on them here:

What Are Frontier Markets? (January 18th, 2010)

The BRICs were last decade’s hotness – like a younger, more innocent, less Dorito-encrusted Britney Spears.  Frontier markets, on the other hand, are looking more and more like your Taylor Swifts and your Katy Perrys – fresh faced and loaded with potential, although still unproven.

Don’t go out and buy anything frontier related without a thorough understanding of the risks involved, which are greater than average.  But certainly, don’t ignore the theme either.

Farmer Brown here again.  One of my key longer-term themes for growth investing is and has been the Agriculture Play for a few years now.  The global demographics, while seemingly moving at a glacial pace to the short-term thinkers, are simply undeniable over the intermediate to longer term.

A recent landmark piece of research from Goldman Sachs suggests that stock market capitalization in emerging countries may grow fivefold over the next 20 years to more than $80 trillion.  Keep in mind that this is the same research department that nailed owning the BRIC country stocks as the Market Call of the Last Decade.

More prosperity reaching the developing world (a majority of the earth’s population) means a historic shift in the world’s diet from simple grains to meats.  The first thing a Third World peasant farmer-turned-industrialist goes upscale on is his food.  And once you go chicken and beef, it’s mighty hard to go back to sprouts. Unless you think that globalization and gentrification will reverse, this shift probably represents the most monumental investing opportunity of our lifetime.

The theme is becoming a well-known one, but now we’ve reached the juncture where we must ask the age old question of “What’s the trade?”.  If there was one takeaway from the book The Greatest Trade Ever, it’s that lots of folks saw the housing and mortgage crash coming, but only a few figured out how to express that awareness into a profitable trade.

The Ag Story is every bit as fat a pitch coming down Broadway for investors as the real estate crash was.  The flash food riots that rippled around the globe briefly in early 2008 were likely a mere preamble to something much bigger, but how do we set ourselves up for it?  The considerations here are getting the timing right, owning the correct vehicles, staying perspicacious in the event that the winners start breaking away from the pack early and, finally, having enough bases covered that you don’t nail the theme but miss the upside (also known as mis-expressing the trade).

Gradually, there are three schools of thought emerging on how to play the Ag Trade.  I will give you a brief idea of what they are and then encourage you to do your own research, as always.  I don’t do advice or tips on this site, that’s my day job.

Anyway, here are the three most common faces of the Ag Trade:

1.  The Landowner

This is a “trade” that has been put on almost accidentally by many commercial farmers and small rural business owners.  They have unsuspectingly woken up in many cases to have found that their farmland has actually been the best-performing asset class in the country for the past decade.

Anecdotally speaking, several clients of mine in the grain and soybean belts have been consolidating the tracts of others for years now in the absence of any readily discernible opportunities in “stupid stocks”.  Over the last year or so, the hedge funds have begun to plow in (pun intended) as well; Connecticut and Manhattan finance types are making land deals in the Heartland like never before.

2.  Seeds and Beans and Husks and Bushels

A second common way that investors are seeking to cash in on the coming Agriculture investment cycle is through commodities and futures themselves.  The vehicle you will most commonly hear about in this context is the PowerShares Deutsche Bank Agriculture ($DBA).

Launched 3 and a half years ago during the 2007 Bull Market in Everything, DBA is essentially a basket of agricultural commodities, like wheat, corn, cocoa, sugar, soybeans and even lean hogs.  These are held in the form of futures contracts which are continuously rolled over.  The ETF basically allows stock investors to potentially benefit from any rise in the prices of these farm products without having to actually buy land, bring in a harvest and go to market (or learn to trade futures).

3.  Agribusiness Tycoon

The third (and most common) play we’re seeing investors put on to get involved with the Ag Trade would be through the businesses themselves, publicly-traded farm outfits in the stock market.  This can be accomplished by owning the names directly or through yet another ETF, this one holding the companies’ stocks as opposed to futures contracts on commodities.

The most popular fund of this type is called the MarketVectors AgriBusiness ETF and it comes complete with a cutesy ticker symbol ($MOO).  MOO holds shares in companies like seed science firm Monsanto ($MON), grain producer Archer Daniels Midland ($ADM), tractor giant Deere ($DE) and fertilizer maker Mosaic ($MOS).  Theoretically, should a major expansion of higher-grade food demand sweep the globe, investors would bet that the goods and services that these agribusinesses offer would become a lot more valuable, along with their stocks.

***

For most investors, buying tracts of arable land in the US or in places like Africa (where China has begun to buy up farms) is not very realistic.  This is why many will chose one of the other two options to express the trade – the Beans or the Businesses.  Use this post as your inspiration to research other vehicles and plays on this theme if you agree with me that it could be one of the young decade’s most important.

And the winner is…Cloud!  The tech industry sub-sector with perhaps this year’s meatiest move is undoubtedly cloud computing.  Names like Riverbed (RVBD), Akamai (AKAM) and 3Par (PAR) have all been putting up insane numbers this year, performance-wise.

My awakening to the group’s potential back in January came courtesy of a great cover story in Barron’s (Sky’s The Limit)- ever since then the cloud computing stocks mentioned (and some that were omitted) have been nothing but fire – in a market that is unchanged year-to-date.

Here’s a peek at the majesty that is Cloud Stock-age thus far in 2010:

Regular readers know that I’ve been hammering away at the cloud theme all year, even hoping for the advent of a Cloud Computing ETF at one point this past spring, albeit in a tongue-in-cheek sort of way (we still haven’t gotten one).

What’s next for the group?

* I have a hard time believing that Cisco has much interest in trailing behind Riverbed in market share for very much longer.  Riverbed’s Steelhead product suite speeds up transmission of applications and data from the cloud to the end user, this is a corporate IT Holy Grail as it allows for the efficient decentralization that global entities need.  I could see Cisco or one of its rivals making a move for this name as this would give them the number one offering in this crucial space instantly.

* Akamai’s global “private web” video serving solution will probably continue to be the delivery method of choice as Web TV becomes a reality and online streaming continues to be monetized.  The wake up call for me on Akamai was when I learned that it was their technology that was the backbone for NBC’s serving of Winter Olympics video to everyone’s mobile devices.

* The bidding war over 3Par (between Dell and H-P) kind of gilds Rackspace’s (RAX) lilly a bit when you think about it.  Rackspace took over an abandoned shopping mall in downtown San Antonio and built an amazingly scaled-up cloud hosting center.  Their fanatical reputation for customer service to their cloud hosted customers is the heart of their story, however – anyone can build a server farm.

* Microsoft’s CEO Ballmer said a few months ago that he was “betting the whole company on the Cloud”.  At the time, he told an audience at the University of Washington that 70% of Microsoft’s engineers were working on cloud-related products.  Maybe he ought to start buying cloud products rather than burning cash in his labs.

All of these stories are showing what I call Oblivious Growth in an otherwise flat GDP environment.  Nice to get a whiff of the secular stuff every once in a while and see that winning stocks can still separate themselves from the hyper-correlation.

So that there’s no confusion, these aren’t predictions or forecasts, they are Outliers.  I define an outlier as an event that is unlikely but possible.  I’m not betting the farm on this stuff, but I wouldn’t fall out of my chair if any of it happened between now and the end of the year.

1. Silver Explodes:  Gold’s flashier little brother has had a decent go of it of late.  Silver prices just broke above the $19.50-ish level for only the third time since November 2009, and you know what they say about “the third time.”  The big boys are usually buying gold right around now to get ahead of holiday demand and the wedding season in India, meanwhile the yellow metal is within melting distance of its high. If the Slingshot Effect that silver prices experience during gold rallies takes hold, look out above. My outlier here is that silver becomes the must-have investment of the season.

2. GOP Takes the House:  It is conventional wisdom that Republicans are going to gain some ground at the mid-term elections this November, but I’m going to go a step further and say that the Dems will lose more than 40 seats and along with them, control of the House.  Larry Sabato, a political scientist from the U of Virginia, has been quoted as saying that they could also lose as many as 8 or 9 senate seats as well.  This ain’t your Daddy’s Midterms, or maybe it is – there are shades of Newt Gingrich’s Contract with America tour-de-force against Bill Clinton halfway through his 1st term back in ‘94.  Peeps is pissed right now.

3.  Google Buys Twitter:  This would be a real outlier if only it didn’t make so much damn sense.  What in the hell are they waiting for in Mountain View, CA?  They tried to build their own Twittery-thing (Google Buzz, anyone?), it wasn’t terrible but people don’t need two microblogging platforms even if Google’s did have the advantage of being bundled with Gmail.  This is a doable deal for Google financially and as incredible a phenomenon as Twitter is, it’s still not a business yet – just a phenomenon.  The Googster ($GOOG) could monetize it on Day 4.

4.  Ballmer is Audi 5000:  He’ll go out like a lamb before this becomes a shareholder revolt thing.  The truth is, he had everything to lose, inheriting the reins when he did with Microsoft ($MSFT) at the very pinnacle of its power.  But Mayor Michael Bloomberg inherited New York City after Rudy Guiliani had ushered in the Big Apple’s Platinum Age and somehow Bloomberg managed to actually improve things.  Ballmer didn’t.  He’s never been in touch with the kids, doesn’t have a particularly impressive vision, is not possessed of much imagination and he’s not a consumer tech guy.  The anti-Steve Jobs will resign and the board will find a consumer-oriented CEO to replace him.  Bill Gates will not be looking to pull a Michael Dell and return to “save the company”; I think he likes his story exactly the way it reads now.

5. Android Rules:  The market share gains for Google’s Android Operating system move from the nascent stage of hotness to the explosive, Jack-Black-in-2005 phase. Verizon stores nationwide continue to push Android phones in the absence of an iPhone product and instead of the now-stale BlackBerry brand.  The mobile handset makers that are not called Apple ($AAPL) have found their Holy Grail, with Android phones taking a respectable 25% market share this past August.  The push by these handset makers to legitimately compete with the iPhone juggernaut will be ramped up throughout the fall and market share will be gobbled at a blistering rate (sorry, Research in Motion $RIMM).  I’ll stop short of predicting outright supremacy over either BlackBerry or iPhone this fall, my outlier here is that Android is about to become the one that haunts both of them.

6. IMAX, Netflix in Play:  There are very few entertainment platforms that haven’t had their throats ripped out by the internet, these are two of them.  There is nothing the internet can do to disrupt the IMAX ($IMAX) experience, one cannot replicate a 70 mm viewing experience in their basement.  Ditto for Netflix ($NFLX) which saw the digital delivery threat years ago and made arrangements to be a big player for the post-DVD world.  These two businesses are the belles of the ball because of their web durability – and they will be chased by media companies into the end of the year.

What are your Outliers for the Fall of 2010?