Consumer discretionary tops US public sector risk analysis in Q3 2023

Consumer discretionary once again led a quarterly S&P Global Market Intelligence analysis of US public sector risk as inflation muted demand for nonessential goods and services.

Risk can exert downward pressure on valuations, potentially drawing the attention of private equity investors on the lookout for deals. On the other hand, it will likely prompt private equity firms already invested in troubled sectors to delay exits from portfolio companies.

The consumer discretionary sector attracted more short sellers betting on stock declines than any other segment in the third quarter through the end of August. It also had the largest percentage of companies revising their earnings outlooks downward. But edging into the sector risk spotlight was healthcare, which scored the highest on probability of default, a third key measure of risk.

Corporate guidance

IT, industrials, consumer discretionary and healthcare were the four sectors with the highest number of publicly traded US companies revising their corporate guidance downward in the last five quarters. Of those four, consumer discretionary companies were the most likely to cut their earnings outlook in the third quarter through Sept. 24, with 19 of 45 companies in the sector, or about 42%, issuing lower corporate guidance.

Examples include The ODP Corp., where executives on the company's second-quarter earnings call cited weaker top-line performance from its Office Depot retail stores when lowering revenue projections. Softer US wholesale trends tied to the impact of inflation on consumers and ongoing supply chain challenges prompted Levi Strauss & Co. to lower its full-year 2023 outlook.

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Healthcare booked the second-highest percentage of lowered corporate guidance among companies in those same four sectors, with about 27% of 106 companies cutting their quarterly or annual earnings expectations, although the data suggests growing unease. The percentage of healthcare sector companies lowering guidance in the third quarter increased 9 percentage points from the previous quarter, the biggest quarter-over-quarter jump of the four sectors analyzed.

Short interest

For 18 months, short sellers have focused their bets on stock-price declines in the consumer discretionary sector, which had the highest average short interest of any sector as of the end of August, two-thirds of the way through the third quarter. Healthcare took the No. 2 position on that measure of risk for the second consecutive quarter.

Probability of default

With a median probability of default score standing at 6.9% as of Sept. 24, healthcare ranked ahead of all other sectors on a measure of credit risk in the third quarter, a position it has held for at least a year.

Median probability of default is based on market-derived signals, including stock price movements. The healthcare sector's score increased nearly a full percentage point from the end of the second quarter, a larger step up than any of the other sectors analyzed in the third quarter.