Investing legend Mohamed El-Erian says he's avoiding stocks as a demand shock looms for oil

• Mohamed El-Erian says he would avoid buying stock indexes at the moment.
• The former Pimco CEO is eyeing a demand shock stemming from the recent spike in oil prices.
• Markets may be mispricing the economic consequences from the Iran war, he suggested.

Mohamed El-Erian has a warning for dip-buyers.

The top economist and former CIO of PIMCO told CNBC he's avoiding stocks at the moment — particularly broad-based stock indexes — as the Iran war enters its second month. He cited the cascade of economic consequences stemming from higher oil prices, and said markets now have to contend with the risk that a demand shock will start to unfurl across the economy.

"That is another tipping point for the global economy," El-Erian said of a potential demand shock. "I've gone from reduced risk to maximum risk-off, to now, a few names look attractive, but I would not be going into the market and buying the index at this juncture."

Stocks have been steadily dragged lower over the past month, with the Dow Jones Industrial Average and the Nasdaq 100 officially entering a correction on Friday.

But, even considering the declines so far, investors are likely mispricing the economic risks stemming from the war in Iran, El-Erian suggested.

"Equities, we still have this mindset that this is transient, that somehow, yes, there's going to be a short-term effect, but we should look through it," he added.

The Iran war has set off a series of economic concerns in markets, which starts with the recent spike in oil prices. The worry is that higher crude prices could stoke inflation, burdening consumers until they pull back on their consumption of oil products.

Barring an increase in supply, demand destruction is necessary to bring oil prices lower. But it risks slowing growth at a time when the US economy was already weakening, leading more forecasters on Wall Street to warn of a possible recession.

Demand destruction is already visible in other parts of the global economy, El-Erian said. He pointed out that Asian countries, which are thought to be the most affected by the closure of the Strait of Hormuz, are now bracing for supply shortages of key goods.

In the US, a demand shock could likely manifest as Americans reining in their spending, particularly among lower-income households, El-Erian said. There could also be ripple effects across the broader financial system, he suggested.

"You start with an energy shock, interest rate shock, broader inflation shock, demand shock. Then if this continues, which I hope it won't, we're going to be talking about financial instability. So that's the sequence. Hopefully we don't go all the way down," he said of the war's aftereffects.

El-Erian has been vocal in recent weeks about the cumulative economic damage since the start of the Iran war. Speaking to Business Insider in mid-March, he said he believed the odds of a US recession had climbed to 35% due to the war, and that hotter inflation was raising the risk for a "financial accident."