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NEW YORK (TheStreet) -- Both policymakers and hedge fund managers alike have taken a cautious tone regarding equity market valuations lately, causing selling pressure in small-cap stocks. This could ultimately limit further moves higher in U.S. equity indexes.

At yesterday's hearing in Congress, Federal Reserve Chair Janet Yellen stated that some aspects of U.S. securities markets, such as biotechnology and social media stocks, were "stretched" in their valuations.

This led to declines in the iShares Nasdaq Biotechnology Index ETF (IBB) - Get iShares Biotechnology ETF Report, MannKind (MNKD) - Get MannKind Corporation Report, Geron (GERN) - Get Geron Corporation Report and Ariad Pharmaceuticals (ARIA) in the biotech space.

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Similarly, prominent social media companies such as Twitter (TWTR) - Get Twitter, Inc. Report, Facebook (FB) - Get Meta Platforms Inc. Class A Report, Yelp (YELP) - Get Yelp Inc Report and LinkedIn (LNKD) sold off.

Yellen's comments came on top of last week's remarks by billionaire activist investor Carl Icahn, who told Reuters that it is time for U.S. stock market investors to tread carefully after the run-up on Wall Street.

"In my mind, it is time to be cautious about the U.S. stock markets," Icahn told the news outlet. "While we are having a great year, I am being very selective about the companies I purchase."

Icahn did not respond to TheStreet's inquiries on investor sentiment on small-cap stocks by press time on Wednesday.

With negative sentiment swirling around equity valuations, the iShares Russell 2000 Index (IWM) - Get iShares Russell 2000 ETF Report has fallen close to 5% off of its highs of $120 in the last two weeks.

Investors are becoming more cautious -- as both Yellen and Icahn recommended -- which has led to the relative leadership of larger-cap names over smaller-cap names. Small-cap stocks are usually perceived as having higher risk and being more speculative.

This issue with small cap stocks lagging is that it threatens to hold back gains in other indexes as well, such as SPDR S&P 500 (SPY) - Get SPDR S&P 500 ETF Trust Report, SPDR Dow Jones Industrial Average (DIA) - Get SPDR Dow Jones Industrial Average ETF Report, and PowerShares QQQ (QQQ) - Get PowerShares QQQ Trust Ser 1 Report.

As is seen on the chart below, all four indices tend to trend higher together and fall in unison as well.

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The Russell 2000 Index declined from March to early May this year, leading to consolidation among other U.S. equity indexes. When the Russell 2000 began to turn up, however, for a few weeks into May, the other large cap indexes broke with their consolidation and resumed their uptrends.

Currently, the Russell 2000 Index looks to be forming strong overhead resistance at record highs of $120. If the formation of a double top completes and the small-cap index breaks to the downside, below $108, it could lead to a prolonged period of selling pressure for all U.S. equities.

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Small-cap stocks look bruised from the negative attention they have been receiving lately, but they are certainly not broken yet.

Small-cap weakness will limit gains in other U.S. indexes, but until small-cap stocks make a significant move above $120 or below $108, the market must remain in "wait and see" mode.


IWM data by YCharts

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At the time of publication, the author had no position in any of the funds mentioned.

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

TheStreet Ratings team rates GERON CORP as a Sell with a ratings score of D-. TheStreet Ratings Team has this to say about their recommendation:

"We rate GERON CORP (GERN) a SELL. This is driven by several weaknesses, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The area that we feel has been the company's primary weakness has been its declining revenues."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The company's current return on equity greatly increased when compared to its ROE from the same quarter one year prior. This is a signal of significant strength within the corporation. Compared to other companies in the Biotechnology industry and the overall market, GERON CORP's return on equity significantly trails that of both the industry average and the S&P 500.
  • The revenue fell significantly faster than the industry average of 26.8%. Since the same quarter one year prior, revenues fell by 38.0%. The declining revenue has not hurt the company's bottom line, with increasing earnings per share.
  • GERN has no debt to speak of therefore resulting in a debt-to-equity ratio of zero, which we consider to be a relatively favorable sign. Along with this, the company maintains a quick ratio of 32.65, which clearly demonstrates the ability to cover short-term cash needs.
  • This stock has increased by 91.44% over the past year, outperforming the rise in the S&P 500 Index during the same period. Regarding the future course of this stock, we feel that the risks involved in investing in GERN do not compensate for any future upside potential, despite the fact that it has seen nice gains over the past 12 months.
  • GERON CORP has improved earnings per share by 33.3% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. This trend suggests that the performance of the business is improving. During the past fiscal year, GERON CORP continued to lose money by earning -$0.29 versus -$0.54 in the prior year. This year, the market expects an improvement in earnings (-$0.24 versus -$0.29).

TheStreet Ratings team rates FACEBOOK INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate FACEBOOK INC (FB) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures and impressive record of earnings per share growth. However, as a counter to these strengths, we find that the stock itself is trading at a premium valuation."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • FB's very impressive revenue growth greatly exceeded the industry average of 21.2%. Since the same quarter one year prior, revenues leaped by 71.6%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • Although FB's debt-to-equity ratio of 0.02 is very low, it is currently higher than that of the industry average. Along with this, the company maintains a quick ratio of 13.15, which clearly demonstrates the ability to cover short-term cash needs.
  • Powered by its strong earnings growth of 177.77% and other important driving factors, this stock has surged by 151.44% over the past year, outperforming the rise in the S&P 500 Index during the same period. Setting our sights on the months ahead, however, we feel that the stock's sharp appreciation over the last year has driven it to a price level which is now relatively expensive compared to the rest of its industry. The implication is that its reduced upside potential is not good enough to warrant further investment at this time.
  • The company's current return on equity greatly increased when compared to its ROE from the same quarter one year prior. This is a signal of significant strength within the corporation. When compared to other companies in the Internet Software & Services industry and the overall market, FACEBOOK INC's return on equity is below that of both the industry average and the S&P 500.