Distinguishing the types of pullbacks is more important than blindly trying to buy the dip

Author: Todd Wenning

Original compilation: Deep Tide TechFlow

Introduction: Academic financial theory divides risk into systemic risk and idiosyncratic risk. Similarly, stock drawdowns are categorized into two types: market-driven systemic drawdowns (such as the 2008 financial crisis) and company-specific idiosyncratic drawdowns (such as the current software stock crash caused by AI concerns).

Todd Wenning uses FactSet as an example to point out: during a systemic drawdown, you can leverage behavioral advantages—patience to wait for the market to recover; but during an idiosyncratic drawdown, you need to analyze—your vision for the company ten years from now is more accurate than the market’s.

In the current environment where AI is impacting software stocks, investors must distinguish: is this a temporary market panic, or is the moat truly collapsing?

Don’t use blunt-force behavioral solutions to address issues that require nuanced analysis.

The full article is as follows:

Academic financial theory states that there are two types of risk: systemic and idiosyncratic.

Systemic risk is the unavoidable market risk. It cannot be eliminated through diversification, and it is the only type of risk for which you can earn a return.

On the other hand, idiosyncratic risk is company-specific. Because you can cheaply buy a diversified portfolio of unrelated businesses, you do not earn a return for bearing this type of risk.

We can discuss modern portfolio theory another day, but the framework of systemic versus idiosyncratic risk is helpful for understanding different types of drawdowns—percentage declines from peak to trough—and how investors should evaluate opportunities.

From the first value investing book we read, we were taught to take advantage of Mr. Market’s despair during stock sell-offs. If we remain calm when he loses his mind, we prove ourselves resilient value investors.

But not all drawdowns are the same. Some are market-driven (systemic), while others are company-specific (idiosyncratic). Before you act, you need to know which type you’re facing.

Gemini Generation

Recent sell-offs in software stocks driven by AI concerns illustrate this point. Let’s look at the 20-year drawdown history between FactSet (FDS, in blue) and the S&P 500 (measured by the SPY ETF, in orange).

Source: Koyfin, as of February 12, 2026

FactSet’s drawdowns during the financial crisis were mainly systemic. In 2008/09, the entire market was worried about the resilience of the financial system, and FactSet was not immune to these concerns, especially since it sells products to financial professionals.

At that time, the stock’s decline was less about FactSet’s economic moat and more about whether its moat mattered if the financial system collapsed.

The 2025/26 FactSet drawdown is the opposite. Here, concerns are almost entirely focused on FactSet’s moat and growth prospects, as well as widespread worries that accelerated AI capabilities could disrupt software industry pricing power.

In a systemic drawdown, you can more reasonably employ time arbitrage bets. History shows markets tend to rebound, and companies with strong moats may even become stronger than before. So if you’re willing and able to remain patient when others panic, you can leverage behavioral advantages with a strong stomach.

Photo by Walker Fenton on Unsplash

However, in an idiosyncratic drawdown, the market is signaling that the business itself has problems. Specifically, it suggests that the terminal value of the business is becoming increasingly uncertain.

Therefore, if you want to capitalize on an idiosyncratic drawdown, you need more than behavioral advantages—you need analytical advantages.

To succeed, you must have a vision for the company ten years from now that is more accurate than what the current market price implies.

Even if you know a company well, this is not easy. Stocks rarely decline 50% relative to the market without reason. Many formerly stable holders—even some investors you respect for their deep research—may have to capitulate for such a decline to occur.

If you want to buy during an idiosyncratic drawdown, you need an answer to why these well-informed, thoughtful investors are wrong to sell, and why your vision is correct.

There is only a thin line between conviction and arrogance.

Whether you are holding stocks in a drawdown or looking to initiate new positions, it’s crucial to understand what type of bet you are making.

Idiosyncratic drawdowns may tempt value investors to seek opportunities. Before taking risks, ensure you’re not using blunt-force behavioral solutions to address issues that require nuanced analysis.

Stay patient, stay focused.

Todd