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The lesson learnt from the GFC that applies to this ASX bear market

Welcome to bear territory! The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is certain to slump into a bear market this morning after US and European share markets plummeted into one in overnight trade.

As it is, it won’t take much to tip us over as the ASX 200 already lost 19.6% of its value from its February 20 peak. A bear market is a fall of 20% or more.

Worst performers

The worst performers on the top 200 include many well-held names. The WiseTech Global Ltd (ASX: WTC) share price takes the wooden spoon with a 52% fall from grace over the past month.

The Oil Search Limited (ASX: OSH) share price isn’t far behind with a 48% tumble (most of which happened yesterday when the oil price collapsed). In third spot is Corporate Travel Management Ltd (ASX: CTD) as the travel sector took the brunt of the coronavirus pain.

If our market closes the day in the red, it would officially kill the 10.5-year bull market. The last time we were in a bear market was during the GFC.

Differences in this bear market to the GFC

Talk about déjà vu! The more important question is whether there are any lessons we can draw from the last bear market that would help us navigate this corona-crisis.

There are distinct differences between the two bear markets. The GFC posed an existential threat to the global banking system and showed how counterparty risks could bring down the world economy. This time, it’s a health crisis that is forcing factories and businesses to close.

While both crises represent a crisis of confidence, the trigger for recovery this time needs to be government-led, unlike the GFC which was led by central banks.

There is a lot riding on the Morrison government’s soon-to-be-announced stimulus package. Our prime minister knows he has to get it right (both in size and scope) if he wants to restore confidence.

The debt monster makes a comeback

However, there is one lesson from the GFC that I think does apply to investors caught up in the current market meltdown. I am not talking about staying calm and the almost certain future share market recovery, even though these are true.

I am talking about debt. You didn’t think we would have to worry about corporate leverage given what companies have learnt during the previous financial crisis.

But the COVID-19 sparked economic rout is putting stress on credit markets and credit investors are becoming very wary about the risk of company defaults.

Leverage before P/E

This isn’t so much an Australian issue as the amount of debt held on corporate balance sheets here aren’t extreme (See? We did learn something from the last time), but credit markets are international and Australia is very reliant on these markets for funding.

In a perverse way, the cost of debt could actually rise, or some companies may get cut off, if panic about defaults continue to grow. This will happen despite government bond yields crashing to record lows.

Bargain hunters looking for value buys during the carnage would be foolish not to look at gearing first before looking at price-earnings ratios.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of and has recommended Corporate Travel Management Limited. The Motley Fool Australia owns shares of WiseTech Global. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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