Bonds have been the great diversifier relative to stocks, yet this relationship is subject to change and can move from negative to positive. So, what does that mean for your asset allocation?
A switch from a -.5 to +.5 will double the volatility of a 60/40 stock/bond mix based on historical data. Think about it. You will see your portfolio can move from single to double digit risk while keeping the allocation the same. There will still be a diversification benefit from bonds, but you will have to live with more risk. Back to basics, the correlations across assets matter.
See the Fidelity working paper, "Liquid alternatives: The power of equity options-based strategies"
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