Understanding the correlation between stocks and bonds for real-world application like investment strategies such as asset allocation and diversification is quite essential. For quite some time, the makeups of a portfolio investment were primarily only stocks and bonds. Stocks allow partial ownership of a publicly traded company and the return on investment is dependent on the earnings growth and dividends. Alternatively, bonds are loans given to an institution in exchange for a steady income at a pre-set interest rate and are generally considered to be a safer investment. An investor can achieve a desired level of riskiness by diversifying his/her portfolio while paying attention to the co-movement of its assets. The purpose is to build a portfolio that contains a lower correlation to each other asset so none will move in the same direction or otherwise known as a positive correlation. The opposite refers to a negative correlation, which is when two investments are moving in different directions away from one another.
We must begin by discussing the driving forces behind the inverse relationship of these two assets. Firstly, bond prices are linked to the prevailing market interest rate. Meaning higher interest rates create a drop in bond prices and lower interest rates create higher bond prices. The interest rate is a function based on economic conditions. Secondly, the intrinsic value of the company’s business plays a large role in determining the worth of stock market value. Likewise, the economic fundamentals of a business are another contributor to the change in price of stock when more people begin to invest in a profitable company. This is an indicator for a healthy and growing economy because it shows businesses are heading towards financial stability. Companies will be able to raise prices, create new jobs, and finance company’s expansion. As profits increase, so do dividend payments. This leads to a lowered overall risk for stock investments since companies are less than likely to declare bankruptcy. This can be represented in the equation: 
This equation tells us that dividends rise in the same direction as the growth rate in a flourishing economy which results in declining risk premiums and lowered stock prices. Lastly, the theory of supply and demand is applicable in the change of asset price. If there are more buyers than sellers who are willing to pay a higher price for a particular asset then the higher price will be achieved when more sellers begin selling until the overall demand tapers off.
Why do the prices of stocks and bonds share a negative correlation? The reason behind this is that stocks and bonds are competing for the same pool of money from investors. For example, if the price of bond increases then the price of the stocks will decrease and opposite is also true. This was never truer than during the Financial Crisis of 2008 that resulted in a falling stock market in a time of economic uncertainty. Investors withdrew most of their money out of the stock market and decided to invest on U.S. Treasury Bonds, which was considered a more conservative investment at the time. This demand effectively raised the price of bonds culminating to a decline in price for stocks. The logic behind this is quite simple. Investors have a limited amount of money they could use and that could only be allocated in assets considered top priority and when most of their money went into bonds, less money could be invested into stocks. As one can expect, the opposite happened during the Economic Recovery of 2009 when people pulled out the bond market and started investing heavily in the stock market. Market data at the time would show the prices of bond plummeting as prices of stock soared.
Why do the stock market and bond market share a positive correlation? This is partly due to the Federal Reserve’s quantitative easing policy. They want to stimulate the growth in the economy by purchasing billions of fixed-income securities per month. This move is becomes beneficial to the stocks and bonds marks when interest rates decrease to an all-time low. The effect this has on the bond market leads to the increase of bond prices and a decline of yields. This in turn makes bonds a more attractive and lucrative investment when interest rates lower. The increase in bond prices is represented with this equation: 
On the flip side, the stock market benefits greatly from the effect of low interest rates. A low interest rate means higher dividend payouts for investors and furthers encouragement with riskier assets.
Bonds and stocks represent the love-hate relationship of the financial world with many ups and downs. There is no easy method to singlehandedly pinpoint the underlying reason as to why stocks and bonds move in a certain direction. What is certain are the cause and effect factors for market prices and never has it been so important for diversification. A right ratio of both stocks and bonds can safely ride out a failing market or make you rich in a booming economy.