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As stocks begin 2015 with a whimper and bond prices rally yet further, markets seem newly preoccupied with the twin threats of a growth shock and deflation. This already puts the bullish consensus on shares and bearish one on fixed-income firmly on the back foot, as the optimism caused by the non-event of the last Federal Reserve meeting (17-18 December, 2014) dissipates.

This is not to say the Fed's influence is waning. Regular readers will recognise the chart below which shows how the US equity market, as benchmarked by the S&P 500, looks to enjoy a close relationship with the size of the US central bank's balance sheet.

The S&P 500 has closely followed the expansion in the Fed's balance sheet

Source: www.federalreserve.gov, Thomson Reuters Datastream, AJ Bell Research

A variation on this, which dates back to 2011 and the conclusion of the Fed's second quantitative easing programme (QE-II) brings the correlation into closer relief. This version shows the percentage year-on—year change in both the index and Federal Reserve assets.

A key test is now upon us as the Fed halts additions to QE

Source: www.federalreserve.gov, Thomson Reuters Datastream, AJ Bell Research

Investors need to keep a close eye on these trends, especially as the Fed stopped adding to its QE scheme back in October. It may be no coincidence that risk assets have found it harder to make progress in the wake of the Fed's decision to turn off the monetary tap, at least for now.

The US authorities have form when it comes to responding to a slide in the American stock market, so the flow of cheap liquidity may not remain closed for ever, but for now Fed Chair Janet Yellen is at leas determined to talk a tough game on monetary tightening. Whether she delivers or not remains to be seen - and this column for one remains sceptical – but for now even the absence of extra QE seems enough to check share prices' momentum, let alone higher interest rates.

As such markets remain delicately poised and it is worth revisiting four indicators of risk appetite flagged regularly here, to assess the current state of play. And important as commodity prices, emerging equity markets, junk debt and small caps are, it may also be worth adding a couple of refinements here, namely energy prices and credit spreads. Unfortunately, neither for the moment offer too much immediate encouragement to bulls but it will be worth watching all of these charts as any inflection points here could flag a return of confidence in policy, the economy and risk assets in general.

The markets in four charts

All four of the themes below frequently headline here but it is a valuable exercise to revisit them as one year ends and another begins.

The first is commodity prices. The chart below shows the Bloomberg Commodities benchmark, which tracks the price of 22 raw materials via the futures markets. Hampered by ongoing weakness in oil, of which more later, the index stands at its lowest level since early 2009.

The Bloomberg Commodities index stands at its lowest mark since 2009

Source: Thomson Reuters Datastream

Theme number two is represented by emerging market (EM) equities. They underperformed their developed market counterparts for the second year in a row in 2014, a trend which hardly smacks of bristling risk appetite amongst clients, despite excellent performances from India and particularly China.

In this graphic, emerging market equities are represented by the MSCI Emerging Market Index and developed markets by the MSCI G7 indicator. Both are priced in dollars, an important consideration given the greenback's inexorable rise in the second half of 2014, itself a further potential indicator of risk aversion.

Emerging markets continue to lag developed ones

Source: Thomson Reuters Datastream

The third trend of note is represented by high yield, or junk, debt. The US-listed Exchange-Traded Funds which track this asset class, the iShares iBoxx $ High Yield Corporate Bond ETF and SPDR Barclays Capital High Yield Bond ETF, both took a pasting in the fourth quarter. Junk bond prices fell and yields rose sharply, not least because around 15% of 2014 junk debt issuance hailed from early-stage shale explorers and developers who have had to confront the threat posed by weak oil prices, according to the Wolf Street blog. These issues are discussed in greater detail here (see Why the slide in Brent crude begs big questions, 5 December 2014).

US-listed junk bond trackers moved sharply lower in late 2014

Source: Thomson Reuters Datastream

Finally, we come to small caps. In 2014 the FTSE AIM All-Share fell by 17% while the FTSE 100 slid 3% and the FTSE 250 eked out a 1% gain. In the USA, the Russell 2000 has lagged the S&P 500 and Dow Jones since last spring. A move to better-financed, stodgier and generally safer large caps after a long bull run was clear to see in 2006 and 2007 and helped to call the top back then. Time will tell whether the same trend is also a harbinger of something serious this time around.

Small caps are still lagging their large-cap peers

Source: Thomson Reuters Datastream

Two last thoughts

If these four indicators start to stabilise or rally then risk assets could swiftly come back into favour and cast aside the gloom which has gathered ever since the Federal Reserve stopped adding to QE last October. If they keep sinking, we could be in for a correction of some size, unless the Fed and the world's central banks put their hand into their pockets again. In that context it is interesting to note the statistic from Bloomberg that the S&P 500 has just recorded its first four-day losing run since 2013.

To add to the four themes above, two related trends are worthy of note. In the commodities sphere, oil's weakness is grabbing all of the headlines, but investors should be aware that all of the energy complex has a soggy feel to it. Coal, natural gas and uranium are all sliding in price, as if to suggest weak demand is at least as responsible for oil's woes as higher supply.

Energy prices are weak across the board, including coal

Source: Thomson Reuters Datastream

...natural gas...

Source: Thomson Reuters Datastream

...and even uranium...

Source: Thomson Reuters Datastream

Add further weakness from 'Dr. Copper' to the mix and the global economy does take on a rather sickly look.

Dr. Copper looks to be entering 2015 with a hangover

Source: Thomson Reuters Datastream

Finally, one variation on the junk bond theme should be noted and this is credit spreads. This refers to the difference in yield offered by different quality bonds from different issuers of the same maturity – the lower-quality the paper the higher a coupon it needs to offer to compensate buyers for the additional risks they are taking. A smaller-than-usual or falling premium – or spread – usually means the markets are in 'risk on' mode, while a greater-than-average or rising premium suggests risk appetite is on the wane.

Lay it on thick

There are several such credit spread indicators, including

• The sovereign spread, which measures the gap in yield on debt from different Governments
• The risk spread, which measures the gap between AAA-rated and BAA-rated corporate bonds
• The default spread, which is investment grade corporate debt relative to Gilts (or UK Government debt)
• The credit quality spread, which benchmarks investment grade corporate paper against junk, or high yield debt.

The first chart below looks at the risk spread (the columns) on a standalone basis for the US market, as set against the actual yield on aggregate AAA and BAA-rated corporate debt. It might not look like much here but the spread has more than doubled in the last four months from 0.47% to 0.96%.

The US risk spread is widening

Source: St. Louis Fed, Thomson Reuters Datastream, AJ Bell Research

The next one runs the risk spread against the S&P 500.

The risk spread correlates well with momentum in US equities

Source: St. Louis Fed, Thomson Reuters Datastream, AJ Bell Research

Investors can draw their own conclusions, since correlation is not the same as cause, but the risk spread looks to be another useful tool when it comes to measuring where equities may go. For the moment, confidence needs a bit of a boost from somewhere and it may be up to Mario Draghi, President of the European Central Bank, and Janet Yellen to supply it when they make their next policy pronouncements on 22 January and 28 January respectively.

Russ Mould, AJ Bell Investment Director.