THE recent moves of the Chinese equity market provoked a flurry of questions directed at economists. Underlying these questions was an assumption that equity markets are in some way intimately linked with the workings of economies. This is not so. In fact, for economists, equity markets are something of a side show.

It is worth emphasising that rising equities are not always a good thing. Suggesting equities had a “good” day if they rose and a “bad” day if they fell does not make economic sense. Equities have a good day if they are fairly valued according to economic fundamentals.

Equities have a bad day if they are deviating from fair value. An equity market that is bubbling ever higher is not “good”. An equity market that, having overheated, corrects down to fair value is not “bad”. Nonetheless, the Orwellian simplicity of “up=good, down=bad” has become so entrenched that even policymakers can be sucked into this.

It is common for policymakers to try to limit “short selling” — the sale of equity one does not own in expectation of a fall in the price. However, it is relatively rare for there to be a ban on using credit to purchase equities in the hope of a rise in the price.

The latter is actually a short selling of cash (one is handing over cash one does not own in exchange for equity), but this is considered acceptable. The false idea that “down=bad” justifies a policy that prevents selling on credit but does not prevent buying on credit.

For economists, a fall in equity markets correcting from a bubble tells us no more about the economic outlook than did the inflated expectations that preceded it.

The relationship between equities and economies is limited. Generally speaking, large companies account for around 40% of private sector activity in an economy and maybe 30% of private employment.

Most business is carried out by small businesses in a modern economy, and the government sector will also be important. In developed economies, companies quoted on the equity market will account for maybe a quarter of total economic activity and a fifth of total employment.

The last two recessions in the G7 economies are a good study of the consequences of this. The most recent recession in the wake of the global financial crisis of 2008 was essentially a small business recession. Large businesses suffered too, but the policy responses have generally helped large businesses a lot more rapidly than they have aided small businesses.

However, the 2001 recession (which, depending on how one wants to define recession, may not have been a recession at all) was primarily a problem for larger companies. Smaller businesses fared relatively better in that economic downturn. Judging the world entirely on the basis of large corporate performance would have given a distorted view of economic performance this century.

Moreover, the relationship between equity markets and their local economy has become ever more stretched as economic activity has become ever more globalised. Large listed companies are increasingly transnational — that is to say a large proportion (often a majority) of their earnings come from overseas sales, and often a large part of their operations and thus costs are incurred overseas. Which equity market these companies are listed on is often little more than an accident of history.

This means that the relationship between equities and individual economies is frayed further. One could make a case that equity markets signal something about a proportion of global economic activity, but to ascribe equity performance to domestic economic activity is dangerous.

So, is there anything equities can tell economists? There are certainly links. Equities are an asset, and as such contribute to household wealth and have a bearing on financial stability. Wealth effects are important to consumer spending, and thus to economics.

Loss aversion is a powerful force for consumers; people dislike losses more than they like profits, so if equities go from 100 to 200 then back to 100, equity holders will be more negative about life at the end of the process than they were at the start.

This has some relevance to China’s recent volatility — equities are higher than they were at the start of the year but that does not mean that there will not be a negative reaction to what has happened to date.

Equity markets should not therefore be ignored, but they need to be seen in their proper context. Equities represent a subsection of any economy, and they are likely to be influenced by global forces as much as domestic forces.

Equities have a bearing on economics, through the wealth effect. Beyond that, there are better indicators to watch as a guide to economic performance.

Paul Donovan is senior global economist at UBS Investment Bank. His latest book, The Truth About Inflation, was published by Routledge in April 2015.

This article first appeared in Opinion, digitaledge Weekly, on Aug 3 - 9, 2015.