A consumer discretionary sector rattled by inflation, recession risk and sticky supply chain issues remained the highest risk sector overall across three measures in the fourth quarter of 2022, according to public sector risk analysis by S&P Global Market Intelligence.
For private equity, sector risk indicators can influence the timing of exits, anticipate trends that could impact portfolio companies and put downward pressure on valuations, creating discounted M&A opportunities.
"Probably the next six to 12 months are going to represent fantastic opportunities for private equity and private equity teams who actually can bear a certain level of risk," said Andrea Guerzoni, global vice chair for strategy and transactions at EY.
Corporate guidance movements
Market Intelligence used three risk criteria — corporate guidance, short interest and probability of default — to look across 11 sectors representing 4,238 companies and filter out the four with the highest potential investment risk.
The first risk measure, the proportion of corporate guidance shifting lower as opposed to higher, shows the consumer discretionary sector ranking just behind industrials. Expectations of a recession and layoffs are likely impacting outlooks, as well as inflation. For example, footwear and accessories retailer Designer Brands Inc. pointed to high inflation and deal-hunting shoppers when it cut its earnings forecast in December last year.
However, the industrial sector was slightly worse, with companies lowering investor expectations for future earnings outnumbering by nearly 3-to-1 those companies expecting to exceed upcoming quarterly or annual performance targets.
Supply chain snags, worker shortages and the relative strength of the U.S. dollar against other currencies were among the challenges commonly cited by companies in the industrials sector that issued lowered corporate guidance in the fourth quarter.
For instance, metal parts manufacturer Velo3D Inc. cited shipment delays that fed into production disruptions for dampening its full-year 2022 earnings expectations. Filtration products company Donaldson Co. Inc. in November last year projected that currency translations would cut 5% from full-year sales figures.
The fourth-quarter 2022 corporate guidance results for industrials also marked a shift for the sector, whose outlook recently appeared more optimistic. Across the sector, corporate guidance leaned more positive than negative through the first three quarters of the year.
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Short interest
Consumer discretionary led all sectors on another risk measure, showing the highest average number of short positions on outstanding shares of stock in the fourth quarter, according to Market Intelligence data. While that average stood at 4.9% as of Dec. 28, 2022, down from a recent high of 5.6% in the second quarter of last year, the relatively high proportion of short positions in the sector is a sign of bearish sentiment among investors.
Probability of default
Turning to probability of default, consumer discretionary was among the top four with a score of 3.9% in the fourth quarter of last year, nearly unchanged from the previous two quarters but a notable increase from 1.7% in the same quarter a year earlier.
The data calculates a one-year probability of default by measuring credit risk based on market-derived signals like stock price movements and asset volatility from an individual company perspective.
The healthcare sector leads in this measure with a median estimate for company default risk at 9.6% based on data collected through the fourth quarter, up from 7.6% in the third quarter, the largest quarter-over-quarter rise in default risk across all sectors.
