Before bottoming out, understand the two types of market pullbacks

Author: Todd Wenning

Translation: Deep Tide TechFlow

Original Title: Before Bottoming Out, Understand the Two Types of Market Pullbacks

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

Todd Wenning uses FactSet as an example to point out: During a systemic pullback, you can leverage behavioral advantages—patience in waiting for the market to recover; but during an idiosyncratic pullback, 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 states that risk comes in 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 a return.
• Conversely, idiosyncratic risk is company-specific. Since you can cheaply buy a diversified portfolio of unrelated businesses, you don’t earn a return for bearing this type of risk.

We can discuss modern portfolio theory another day, but the systemic-idiosyncratic framework is very helpful for understanding different types of pullbacks (the percentage decline 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 to be resilient value investors.

But not all pullbacks 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 caused 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 declines during the financial crisis were primarily 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 because 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 mattered if the financial system collapsed.

The decline in FactSet in 2025/26 was the opposite scenario. Here, concerns were almost entirely focused on FactSet’s moat and growth potential, as well as widespread worries that the rapid advancement of AI capabilities would disrupt software industry pricing power.

In a systemic pullback, 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 provided by Walker Fenton on Unsplash

However, in an idiosyncratic pullback, the market signals that the business itself has issues. Specifically, it suggests that the future value of the business is becoming increasingly uncertain.

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

To succeed, you must have a vision of the company’s future 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 pullback, 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 pullback or looking to initiate new positions, it’s crucial to understand what kind of bet you’re making.

Idiosyncratic pullbacks 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