Four Quadrants Framework

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In The General Theory of Portfolio Construction (2024), Charles Gave presents an investment framework he developed in 1978 after watching Nixon break the gold standard and financial markets descend into chaos.

Now 81, Gave has refined his four quadrants model through five decades of market cycles, offering an approach to asset allocation that depends on just two variables: (1) economic activity and (2) price trends.

Gave observed that economies cycle through four distinct environments, and each environment favors different assets. Get the environment right, and you know what to own. Get it wrong, and you’ll struggle with generating outsized returns.

The visual below describes the four quadrants framework:

The horizontal axis measures economic activity, whether businesses are expanding or contracting.

The vertical axis tracks prices, whether we’re experiencing inflation or deflation.

This creates four quadrants, each representing a distinct economic environment.

Gave defines deflationary boom as "the natural state of capitalism" where entrepreneurs figure out how to produce more goods and services using fewer resources, whether through technology, better processes, or innovation.

This efficiency means production volumes rise while prices fall, with businesses passing savings to consumers.

In this environment, innovative companies with pricing power thrive because they can maintain margins through differentiation, while companies without pricing power struggle as general price levels decline.

Beyond individual stocks, most long term investments perform well in this quadrant, including bonds and real estate, since economic growth combined with stable or falling prices makes future income streams more valuable.

For context, the 1990s tech boom and the 2010s expansion both occurred in this quadrant.

Wars, massive infrastructure projects, or a rapid rise in government spending as a share of GDP push both prices and economic activity higher.

In this environment, stores of value dominate returns, including gold, commodities, real estate, and high fixed cost cyclical producers. Value managers and emerging market managers also tend to perform well during these periods.

Companies with high fixed costs particularly benefit as inflation reduces their debt burden while revenues rise with prices. In contrast, bonds suffer terribly, as rising yields fail to compensate for the erosion of their fixed payments.

The 2000s embody this quadrant when China's growth drove commodity demand higher while central banks kept rates low.

Stagflation represents the investor's nightmare. Prices rise while the economy contracts. "Very few assets do well," Gave writes. "Long duration assets do especially poorly."

Economies often get pushed into stagflation through energy price spikes. When this happens, you should own cash in the safest currency, since even bonds collapse, and usually energy positions since they're often driving the inflation.

Gave also advises selling financial assets because they suffer in stagflation. Earnings collapse, dragging down stock prices, while inflation eats away at bond values.

The 1970s oil shocks created the most famous inflationary bust, with oil prices quadrupling, inflation hitting double digits, and the economy falling into recession. Cash and energy positions provided the only protection.

Both prices and sales volumes fall in this environment. Companies cannot repay the principal of their debt, bankruptcies surge, and asset prices collapse across the board.

Only long dated government bonds rise as investors flee to safety and interest rates plummet.

In 2008, long Treasuries returned over 20% while stocks halved. Corporate bonds collapsed alongside equities as credit spreads exploded. Real estate crashed. Commodities plummeted. Gold initially fell before recovering.

Government bonds became the only winning trade as the Fed slashed rates to zero and investors sought safety above all else.

Gave spent decades searching for reliable indicators to identify which quadrant the economy occupied.

The problem was that official economic data arrives late and gets revised, while market prices reflect emotion as much as fundamentals.

His solution was to let market relationships themselves provide the signals.

First, Gave recognized that "the economy is nothing but energy transformed." This means that economic output depends on how efficiently businesses convert energy inputs into goods and services.

~80% of the energy consumed in the world comes from fossil fuels such as coal, oil, and natural gas:

The concept is simple:

For measuring energy costs, Gave looks at the WTI (oil price) in gold terms (WTI/Gold), which provides a proxy of energy costs over time:

But to determine which quadrant investors are in, he uses the S&P 500 to WTI ratio (S&P 500/WTI), a proxy measure for energy efficiency.

Since S&P 500 companies represent most of the private sector's economic activity, their combined value serves as a proxy for what the economy produces. WTI prices represent the cost of energy needed to run factories, transport goods, and power offices.

Gave tracked this relationship over more than a century to show how the ratio predicts economic expansions and contractions:

Here’s the rule to determine whether you're on the right or left side of the four quadrants:

We created a chart tracking the S&P 500/WTI, as pictured below (see web post for interactive chart):

As of Sept. 30, 2025, the S&P 500/WTI ratio stands at 107.07, above its seven-year SMA of 99.33. This places investors on the right side of the quadrants, signaling boom conditions.

For years, Gave tried to model future inflation using:

Gave then realized what mattered wasn't whether prices were accelerating, but whether the bond market was protecting investors against rising prices. He wanted to know: were long-dated US treasuries a proper store of value?

To answer this, Gave uses gold as a standard of value and computes the ratio between gold prices and 10-year Treasury total returns (Gold/US10YT):

Here's how to determine whether you're in the top or bottom half of the quadrants:

We also created a chart tracking gold relative to Treasury bonds using IEF (Gold/IEF), the iShares 7-10 Year Treasury ETF (again, see web post for interactive chart):

Since 10-year Treasury total return data is difficult to access for retail investors, IEF serves as a suitable proxy. It captures both bond price changes and interest payments, closely approximating the total return measure Gave uses.

As of Sept. 30, 2025, the Gold/IEF ratio stands at 40.05, above its seven-year SMA of 36.54. This indicates gold is outperforming bonds, signaling currency debasement and placing investors in the top half of the quadrants.

Combined with the SPX/WTI signal showing boom conditions, investors are currently in an inflationary boom quadrant. This environment favors real assets like gold, commodities, and real estate over bonds.

Having discovered that these two ratios (S&P 500/WTI and Gold/US10YT) effectively identify quadrant positions, Gave realized the original axes, "economic activity" and "prices," were too vague.

What the ratios actually measure is far more specific: (1) energy efficiency and (2) currency quality. So, for the first time since establishing the four quadrants in 1978, Gave renamed the axes to reflect these measures:

The horizontal axis now tracks "energy efficiency" vs. "energy inefficiency." The vertical axis shows "good currency" vs. "bad currency."

The four investment environments and what to own in each haven't changed, but now each gets a score based on combining the two ratios:

As of Sept. 30, 2025, we find ourselves in scenario three: an inflationary boom (as previously discussed), scoring +1 for energy efficiency but -1 for currency debasement, netting to zero. This mixed environment suggests favoring real assets over bonds and cash.

Gave then combined these quadrant readings with the S&P 500 to gold ratio (S&P 500/Gold) to see how different economic environments performed over the past century:

The results show a clear pattern:

Gave also observes that when S&P 500/Gold falls below its seven-year moving average, this has often preceded the same in S&P 500/WTI by a few months. This provides early warning that energy efficiency may soon deteriorate, potentially shifting the economy from boom to bust.

Interestingly, since 2018, both stocks and gold have posted similar gains, which represents what economists call "monetary illusion." As Gave puts it, neither asset has actually risen; the gains simply reflect US dollar currency debasement:

After 54 years in markets, Gave concludes that success comes not from predicting the unpredictable but from recognizing which economic environment you're in and positioning accordingly.

No single strategy works in all environments. However, those who recognize the quadrant shifts and adapt their portfolios can prosper through each cycle.

While this post covers Gave's four quadrants framework and how to identify your current position, read the book to learn additional portfolio strategies not discussed here:

These additional insights and data help turn the four quadrants concept into a realistic investment approach.