Consumer discretionary continued its run at the top of S&P Global Market Intelligence's quarterly analysis of US public sector risk as inflation-wary consumers remained cautious spenders.
Elevated risk in a sector can pull down valuations and set the context for private equity dealmaking, potentially drawing bargain-hunting private equity investors. It can also prompt private equity firms with existing investments to delay exits until those valuations recover.
Private equity investment in the consumer discretionary sector plunged year over year in the first half of 2023 as inflation and a murky macroeconomic outlook took their toll. But several $1 billion-plus acquisition announcements arrived in the second half, including Blackstone Inc.'s $2.36 billion take-private bid for pet care business Rover Group Inc. in November.
Consumer discretionary companies were the most shorted stocks on US exchanges in the fourth quarter through Nov. 30, 2023, and they were the most likely to issue lowered corporate guidance through Dec. 11, 2023, signs of a shaky outlook. Consumer discretionary also ranked among the top five sectors on an analysis of default probability, although it was running well behind the leading sector, healthcare.
Bearish sentiment
Investor skepticism toward the consumer discretionary sector was a theme throughout 2023. The sector held the top spot all year on a ranking of sectors by average short interest, a sign that shareholders were anticipating price declines.
Split outlook
As of Dec. 11, 2023, most fourth-quarter updates to corporate guidance emerged from four sectors: information technology, consumer discretionary, industrials and healthcare. The majority of those updates shifted quarterly or annual performance expectations higher.
The exception was consumer discretionary, where new corporate guidance issued in the fourth quarter was split 50-50 between raised and lowered expectations, possibly reflecting cautious spending by consumers in the current macroeconomic environment.
Some companies in the sector said consumer hesitancy has impacted forecasts. Fast-casual restaurant chain Noodles & Co. pulled back the upper bound of its full-year revenue estimate in November based, in part, on a year-over-year decline in comparable restaurant sales resulting from lighter business at already-open stores. European Wax Center Inc., a franchisor and operator of waxing salons, pared back its full-year sales and revenue projections that same month, citing recent customer surveys that indicated economic concerns would limit the frequency of their visits and how much they were willing to spend on waxing services.
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Omnichannel retailer Kohl's Corp. was among those consumer discretionary-sector businesses that revised guidance upward in the fourth quarter, raising its low-end estimate for full-year diluted earnings per share, while still acknowledging the anxieties of its customer base. CEO Thomas Kingsbury described "persistent macroeconomic pressures on our customer" on a November earnings call.
Credit risk
Healthcare led all other sectors on a measure of credit risk in the fourth quarter, with publicly traded US healthcare companies holding the highest median probability of default score as of Dec. 11, 2023. The sector's 6.5% score, based on market-derived signals like stock price movements, was nearly unchanged from the third quarter.
The healthcare and consumer discretionary sectors together accounted for half of the 54 private equity portfolio company bankruptcies announced in the first half of 2023, amid a rapid rise in bankruptcy filings by companies with private equity or venture capital backing.
The consumer staples sector saw the largest quarter-over-quarter increase in the median probability of default score, up less than a percentage point from the third quarter.
