Almost four months ago, in November 2008, I suggested to get rid of risky stocks, including financials, and to load up on pharma stocks instead (see “Sell Risk, Buy Pharma,”), in part based on former Raymond Jones analyst and now hedge fund manager Michael Krensavage’s analysis of the pharma sector about a year ago. Specifically, I recommended (in alphabetical order) Forest Laboratories (FRX), Johnson & Johnson (JNJ), Merck (MRK), Noven Pharmaceuticals (NOVN), Pfizer (PFE), Schering-Plough (SGP), and Wyeth (WYE), as a portfolio to get through the choppy market.

There is a sketch by comedian Tom Green where he stands outside on the deck of a boat in the middle of a storm and proclaims: “It’s crazy!” However, as the intensity of the storm continues to increase, Green has to repeatedly correct his earlier assessment: “When I said it was crazy [earlier], it wasn’t crazy. Now it’s crazy!” This is how many value investors must have felt about the market this year. I know I did.

Back in May, I wrote an article for Seeking Alpha where I essentially alleged that the market might have reached a low point in March, and recommended to buy stock. As examples for buys, I suggested E*Trade (ETFC) and Alvarion (ALVR). Alvarion I liked also because the Israel-based company was suffering from a high shekel and low U.S. dollar at the time, and I found that the dollar was underpriced and bound to recover eventually (I used a comparison to the buying power of the Euro to show the disparity). I also felt pretty good about my stock picks at the time—both E*Trade and Alvarion were already up about 30% since I had bought them in March. Indeed, one could have made over 70% profit on ALVR by buying at its lowest point in March and selling at its highest point in May. Today, both stocks trade closer to around 30% of their March share price levels rather than 30% above them.

The network effect, an effect famously exploited by AT&T’s (T) predecessor Bell Telephone’s president, Theodore Vail, to achieve monopoly power (one telephone is useless, but if everyone has one, it’s priceless), has been a dominant business model for internet companies for over a decade. eBay (EBAY) is no exception, owing its success of its online auctioning business to that same effect (the more buyers and sellers trade on eBay, the more valuable the site becomes to its users, and the less inclined they are to go someplace else), and earning “de facto monopoly” status—or so it seems. However, it appears that the only thing that is keeping eBay alive anymore is that network effect, which may be drowning it at the same time.

I have been an eBay member myself for eight years, and have noticed how increasingly cumbersome and error-prone its web site has become. But my personal experience pales in comparison to the dissatisfaction users have voiced all over the Internet on blogs and discussion sites (amazingly, this includes eBay’s own blogs: go to blogs.eBay.com and search blog titles for “eBay sucks”).

In the July 2008 issue, Jack Hough of Wall Street Journal’s magazine Smart Money criticizes the rise of “hold” recommendations issued by analysts, 48% last year according to Bloomberg. He says, and rightly so, that analysts should only issue “buy” or “sell” ratings, and asks which of the two a “hold” rating is supposed to be. His introduction about Americans having become accustomed to “nice” reviews insinuates that some “hold” ratings may be nicely put, disguised “sell” ratings.

Indeed, Bloomberg News reports that “[i]nstead of saying ‘sell,’ analysts have stuck with ‘hold’ ratings that are less likely to antagonize the senior executives they’re monitoring, . . . .,” according to Tom Larsen, a former Credit Suisse Group analyst who is now at Harding Loevner Management LP. The “hold” rating “signal[s] to institutional investors that a company is in decline,” a “tacit understanding” to “sell stocks downgraded to hold.”

Contrary to consumer behavior in retail, investors tend to shy away from the stock market when shares are cheap, but seem to be drawn to it like moths to a flame during market bubbles, when prices are highly inflated. In its June 2008 issue, The Wall Street Journal’s magazine “Smart Money” published a chart showing how investors are pulling money out of mutual funds during down markets. In other words, they are selling low.

Another example: Between 1973 and 2002, NASDAQ stocks gained an annual average of 9.6%. Yet, on average, investors only earned about 4.3% annually. One reason: $1.1 trillion were invested late in the game, between 1998 and 2000, when stock prices were highly inflated and the internet bubble burst soon after. And it is not just individual investors who fall victim to this behavior; Merrill Lynch’s professionals, for example, have been accused of getting into the dot.com bubble late as well.

The subprime mortgage crisis has been daily news for many months. The Federal Reserve has lowered interest rates a number of times. Bear Stearns (BSC) collapsed and was absorbed by JP Morgan (JPM). E-Trade (ETFC) survived, but barely. Shares of subprime lenders like Countrywide (CFC) lost substantial value, as well as many big names in the banking industry, including Citigroup (C), Wachovia (WB), and Bank of America (BAC)--which is now acquiring Countrywide--and speculation continues as to how much worse it will get. However, with all the focus on the domestic credit crisis on Wall Street, investors may overlook another danger lurking from the other side of the Atlantic.

Complaints about lax regulation of the U.S. financial industry have become commonplace. But relative to Europe, the domestic industry is more strictly regulated: National banks are regulated by the Federal Reserve and the OCC (savings associations by the OTS and credit unions by the NCUA; state banks are regulated by the states’ pertinent overseeing agencies) and further by the FDIC where deposits are insured; and the securities business is regulated by the SEC. The banking and the securities business are two separate sectors of this country’s tripartite financial services system (the third sector is the insurance business, which is state-regulated).