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 (like the current software stock crash caused by AI concerns).

Todd Wenning cites FactSet as an example: during a systemic drawdown, you can leverage behavioral advantages—patience and waiting for the market to recover; but during an idiosyncratic drawdown, you need analytical advantages—having a clearer vision of the company’s prospects ten years from now than the market does.

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.

Full text below:

Academic financial theory considers risk to be of two types: systemic and idiosyncratic.

• Systemic risk is unavoidable market risk. It cannot be eliminated through diversification, and it’s the only type of risk from which you can earn returns.
• On the other hand, idiosyncratic risk is company-specific risk. Because you can cheaply buy a diversified portfolio of unrelated businesses, you will not earn a return for bearing this risk.

We can discuss modern portfolio theory another day, but the systemic-idiosyncratic framework is very helpful for understanding different types of drawdowns (percentage decline from peak to trough) and how investors should evaluate opportunities.

From the first value investing book we pick up, we are taught to take advantage of Mr. Market’s despair during stock sell-offs. If we stay calm when he loses his mind, we prove ourselves to be 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 generated

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, blue) and the S&P 500 (measured via the SPY ETF, orange).

Source: Koyfin, as of February 12, 2026

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

At that time, the stock decline had little to do with FactSet’s economic moat; it was more about whether the moat would matter if the financial system collapsed.

The 2025/26 FactSet drawdown was the opposite. Here, concerns were almost entirely focused on FactSet’s moat and growth potential, along with widespread worries that AI’s rapid capabilities would disrupt software industry pricing power.

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

Photo by Walker Fenton on Unsplash

However, in an idiosyncratic drawdown, the market is signaling that the business itself is in trouble. Specifically, it suggests that the future 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 clearer vision of what the company will look like ten years from now 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 long-term holders—even some investors you respect for their deep research—may have to capitulate for such a decline to happen.

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’s only a thin line between conviction and arrogance.

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

Idiosyncratic drawdowns may tempt value investors to start looking for opportunities. Before you take the risk, make sure you’re not using blunt behavioral solutions to address issues that require nuanced analysis.

Stay patient, stay focused.

Todd