As North American economic momentum continues to be positive, the consumer-discretionary sector is the place to be, says Marie-Eve Savard, a Montreal-based vice-president at Manulife Asset Management.
"We do like what we see in terms of the macro environment," says Savard, lead manager of the 4-star rated Standard Life Monthly Income. "We are in a period of moderate global growth. There have been some hiccups along the way and it has been a bit slower. But we think that monetary conditions are getting easier (outside North America) and that will be a driver for growth. And we like cyclical sectors outside of resources."
Although Savard is mainly a bottom-up investor, the fact that the U.S. economy has proven to be a standout in a moderate global growth environment is a key part of her thesis. "We have a strong U.S. consumer. So from a macro standpoint, the sector makes sense," says Savard, noting that the employment picture is improving and rising house prices are encouraging homeowners to spend on renovations. "Look at auto sales in the U.S. They are back to the peak. And in Canada, we're not in such bad shape."
Much has been made of rising household debt in Canada. Yet, Savard points out, when one strips out health costs from household debt levels, Canadians are actually less indebted than Americans, with an average debt-to-disposable-income ratio at 157.9%, versus 171.3% for U.S. households.
"With low interest rates, Canadians can afford the debt they are carrying. And with the U.S. recovering, Canada should benefit from that," says Savard, a bachelor of commerce graduate from HEC Montréal, who in 2002 joined Standard Life Investments Inc. after four years as an analyst on the sell side of two bank-owned brokerage firms. (Standard Life was acquired earlier this year by Manulife.)
Savard has overweighted the consumer-discretionary sector, which accounts for 11% of the balanced fund's equity weighting. That's higher than the sector's 8% weight in a blended benchmark of the S&P/TSX Composite Index and S&P 500 Index.
A second positive factor for the sector is expanding operating margins. "With healthy company top lines, we are seeing good operating leverage," says Savard. "By using technology and better systems and improving productivity, you get margin expansion. Combined with lower debt financing, this results in pretty healthy earnings-per-share (EPS) growth." She adds that the consumer-discretionary sector's median 14% EPS was the best in the second quarter in North America.
A third positive factor is the opportunity to gain international exposure. "There are a few companies that have large operations in the U.S. and benefit from the U.S. dollar when they translate their results," says Savard. She points to firms such as 
Gildan Activewear Inc. GIL, which have profited from considerable exposure outside of Canada.
Fourth, Savard notes that the competitive retail environment has forced Canadian retailers to impose greater discipline. "The strong players are getting stronger and gaining market share," says Savard. For example, Canadian Tire Corp. CTC.A responded to the threat of Target Corp. TGT by working more closely with its own suppliers. It has also grown through acquisition. "They acquired Forzani Group, known under the Sport Chek banner, and same-store sales are excellent in that space. This has provided Canadian Tire with new growth avenues."
Fifth, with interest rates set to rise in the U.S., consumer-discretionary stocks should exhibit sustainable dividend growth that Savard believes will outperform traditional dividend-yielding defensive stocks such as utilities. "Companies that have higher yields will be under more pressure. Their valuations are more based on the direction of interest rates. Right now, they are pricey relative to the market," says Savard.
Sixth, valuations are attractive. Savard points out that on the basis of their price-earnings-to-growth (PEG) ratio, consumer-discretionary stocks are trading at 1.1 times 2016 earnings, versus 1.2 times for the S&P/TSX Composite Index. On a price-earnings basis, they trade at 14.3 times 2016 earnings, or a 6.5% discount to the index.
Are there downside risks to Savard's scenario? One concern is that the picture could darken if energy and resources rallied. "What I worry about is if there is interest in those sectors, the money will have to come from somewhere," says Savard. "But we are active managers. So we will respond when we see fit."
With a bias to dividend-growth stocks, Savard likes names such as Home Depot Inc. HD, which has a 2% dividend yield. "It's a great way to leverage the housing recovery in the U.S.," she says, adding that the firm should continue to deliver mid-single-digit growth of same-store sales. Over the past three years, dividends have seen a 25% compound annual growth rate.
Another favourite is Cineplex Inc. CGX, a leading entertainment provider with a 3.3% dividend yield. "It is growing its media offerings and concessions," says Savard, noting that advertising in theatres is on the upswing. "It's showcasing much better growth at very high margins."
