Author: Todd Wenning
Compiled by: TechFlow TechFlow
Original title: Before buy the dips, understand the two types of market pullbacks.
TechFlow Dive: Academic financial theory categorizes risk into systemic risk and idiosyncratic risk. Similarly, stock drawdowns are also divided 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).
Using FactSet as an example, Todd Wenning points out that during a systematic pullback, you can leverage behavioral advantages (patiently wait for the market to recover); but during idiosyncratic pullbacks, you need analytical advantages—a more accurate vision of the company ten years from now than the market.
Amid the current AI-driven surge in software stocks, investors must distinguish between temporary market panic and a genuine collapse of competitive advantages.
Don't use blunt, reactive solutions to solve problems that require nuanced analysis.
The full text is as follows:
Academic financial theory posits that risk has two types: systematic and idiosyncratic.
Systemic risk is an unavoidable market risk. It cannot be eliminated through diversification, and it is the only type of risk where you can earn a return.
On the other hand, idiosyncratic risk is company-specific risk. Because you can cheaply buy diversified portfolios of unrelated businesses, you don't get paid for taking on this kind of risk.
We can discuss modern portfolio theory another day, but the systematic-trait framework is helpful for understanding different types of drawdowns (from the percentage decline of an investment from its peak to its trough) and how we, as investors, should assess opportunities.
From the moment we picked up our first book on value investing, we were taught to take advantage of Mr. Market's frustration during stock sell-offs. If we remain calm when he loses his temper, we will prove ourselves to be steadfast value investors.
But not all drawdowns are the same. Some are market-driven (systemic), while others are company-specific (trait-based). Before you act, you need to know which type you are looking at.
Gemini generation
The recent sell-off in software stocks due to AI concerns illustrates this point. Let's look at the 20-year drawdown history between the FactSet (FDS, blue) and the S&P 500 (measured by 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 concerned about the durability of the financial system, and FactSet was not immune to these concerns, especially since it sold products to financial professionals.
At the time, the stock pullback had little to do with FactSet's economic moat; it was more about whether FactSet's moat would be important should the financial system collapse.
The FactSet pullback in 2025/26 presents the opposite scenario. Here, concerns are almost entirely focused on FactSet's moat and growth potential, as well as the widespread worry about accelerating AI capabilities disrupting pricing power in the software industry.
During systemic pullbacks, you can more rationally make time arbitrage bets. History shows that markets tend to rebound, and companies with strong moats may even become stronger than before, so if you are willing and able to remain patient when others are panicking, you can leverage a strong appetite to take advantage of behavioral behavior.
Photo courtesy of Walker Fenton on Unsplash
However, during a idiosyncratic pullback, the market tells you that there's something wrong with the business itself. In particular, it suggests that the business's terminal value is becoming increasingly uncertain.
Therefore, if you want to leverage trait-based drawdowns, you need to have analytical advantages in addition to behavioral advantages.
To succeed, you need a more accurate vision of what your company will look like ten years from now than what the current market price suggests.
Even if you know a company very well, this isn't easy. Stocks don't usually drop 50% relative to the market for no reason. This happens when many previously loyal holders—even some investors you might respect for their in-depth research—have to give up.
If you're going to step in as a buyer during a traited pullback, you need an answer to explain why these otherwise well-informed and thoughtful investors were wrong to sell, and why your vision is correct.
There is only a fine line between conviction and arrogance.
Whether you hold stocks that are in a pullback or want to start a new position in them, it’s important that you understand what type of bet you’re making.
Traited pullbacks can tempt value investors to look for opportunities. Before you take the plunge, make sure you're not using a blunt, behavioral solution to solve a problem that requires nuanced analysis.
Be patient and stay focused.
Todd
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