Consumer discretionary ranked as the highest risk sector across the aggregate of three indicators of public market risk, according to first-half 2022 data from S&P Global Market Intelligence.
For private equity, sector risk impacts valuations and timing for IPO exits, special purpose acquisition company launches and take-private deals. It can also signal a buying opportunity.
"The question really to ask is, is this a good time to get in, when valuations are reasonable?" said Jim Andersen, founder and managing principal of Clearview Capital LP, in an interview. "Because it's so important that you ascribe an appropriate valuation on the way in."
Cameron Joyce, Preqin's senior vice president and deputy head of research insights, said in emailed comments that public sector risk plays an essential role in private equity allocation, particularly in the current market.
"The new macroeconomic environment is having a significant impact on how risk assets are priced across the board," Joyce said. "However, the price discovery process will be quicker in public markets, so that provides critical information for private market participants as to how future trends will play out."
Sector risk criteria
Market Intelligence used three risk criteria — corporate guidance, short interest and probability of default — to look across all sectors and filter out the four with the highest potential investment risk.
The consumer discretionary sector had a more than 360% second-quarter jump in the number of companies that announced lowered guidance for the upcoming quarter or full year, the highest percentage change across all sectors. Second and third in lowered guidance were the industrial and healthcare sectors, respectively.
Additionally, consumer discretionary recorded the most shares shorted as a percentage of outstanding shares. The data also shows momentum, with the number moving up since late 2021 as investors increasingly bet on a decline of company share prices.
The sector is under downward pressure due to soaring inflation, Andersen said.
"If you think about what percentage of a consumer's budget goes to food and gasoline, well, whatever was left over is now also being spent on food and gas. A lot of consumer discretionary [companies] are going to get hurt because I don't think inflation is going to moderate anytime soon," Andersen said.
* Click here to download data featured in this story in Excel format.
The third factor, probability of default, was clearly most prevalent in healthcare. 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.
Private equity considers sector risk when assessing investment, but the weight it gets depends on the size of the deal and targeted company, Andersen said. For firms like Clearview, which targets the low middle-market, company-specific risk gets more emphasis than industry risk.
Firms targeting larger companies tend to do the reverse.
"A company that's billions of dollars in size can't grow very much differently than the industry it's in, whereas we're looking at businesses that can grow much more quickly than the industries that they play within," Andersen said.