Businesses in the consumer discretionary sector remained among the riskiest bets for investors in the second quarter as inflation pressures and signs of softening demand raised red flags for providers of nonessential goods and services.
Consumer discretionary led on two of four measures of sector risk that S&P Global Market Intelligence regularly analyzed. High or rising risk can dent the valuations of businesses in a sector. Those shifts can, in turn, affect private equity dealmaking, delaying exits of portfolio companies or prompting firms to scour troubled sectors for cut-rate entries.
The risk signals for consumer discretionary come from both senior management, in the form of lowered corporate guidance, and investors, reflected in short-selling data.
Signs of risk, meanwhile, are cropping up in healthcare and real estate. The probability that businesses will not be able to pay back outstanding loans remained highest in healthcare and had the largest quarter-over-quarter increase in real estate, according to S&P Global Market Intelligence data.
Corporate guidance
Twenty-four publicly traded consumer discretionary businesses issued updated corporate guidance between the start of the second quarter April 1 and June 23, with 10 of them lowering performance targets — roughly 42% of the total. By comparison, 33% of companies in the information technology sector issued downgraded guidance in the second quarter and 18% of companies in the healthcare sector did the same.
Foot Locker Inc. CEO Mary Dillon, speaking during the company's May earnings call, tied the company's more pessimistic sales outlook to consumer retrenchment following a better-than-expected holiday season late in 2022, with "rapid inflation ... squeezing their ability to spend on discretionary items, including athletic footwear."
Department store operator Macy's Inc. also cut sales expectations for 2023. CEO Jeffrey Gennette said during the company's June earnings call that lower- and middle-income consumers were spending less on discretionary items.
– Read about PE's growing share of deals with earnouts. – Catch up on the Q2 decline in PE-backed take-private deals.
– Download a spreadsheet of data from this story.
Short interest
Investors continue to view publicly traded consumer discretionary businesses as the most likely to experience stock price declines. The sector led all others in the second quarter with 5.71% of outstanding shares sold short, increasing slightly from 5.60% in the first quarter. Average short interest also ticked up a fraction of a percentage point for the healthcare and communication services sectors.
Probability of default
Credit risk ran highest in the second quarter in the healthcare sector, where publicly traded companies had the highest median default score based on market-derived signals, including stock price movements. Still, the sector's 6.2% median score was down from 6.5% in the first quarter and 6.6% in the second quarter of 2022.
The real estate sector had the biggest quarter-over-quarter increase in probability of default, increasing to near 4% in the second quarter from just above 3.1% in the first quarter.
The overall probability was higher for healthcare and communication, but the probability of default for both sectors declined slightly in the second quarter compared to the first quarter.
