Middle East tensions could unleash a 2-part worst-case scenario that hits stocks, Morgan Stanley says

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The worst-case scenario for stocks could come out of tensions between Israel and Iran, Morgan Stanley said.
The bank said its bear case for stocks was oil prices spiking near the end of the business cycle.
Oil prices climbed in the heat of the Israel-Iran conflict, but have cooled after the cease-fire.
Tensions in the Middle East could spark a series of dire developments for the stock market, strategists at Morgan Stanley said this week.
In a note to clients, the bank pointed to the conflict that's unfolded between Israel, Iran, and the US over the last 12 days, with Israel and Iran agreeing to a cease-fire on Monday.
Tensions, though, contributed to a spike in oil prices in the last week. While crude is back down, a big jump higher in oil stemming from any Middle East conflict is something that could raise the risk of a recession and lead to the most pessimistic outcome for stocks, the bank said.
"The bear case scenario for equities tied to the recent events in the Middle East would be that oil prices rise significantly, thereby posing a threat to the business cycle," strategists wrote.
Morgan Stanley's bear-case scenario has two parts that "materially" raise the risks posed to markets, the note said.
Oil prices rise at least 75% on a year-over-year basis. That implies Brent crude trading around or over the $120 per barrel range, strategists said.
In order for oil prices to trade that high, it would probably require "sustained" disruption to oil supply in the Strait of Hormuz, they added, a key passage for oil exporters in the Middle East.
Crude prices dropped significantly from their highs last year, and have also cooled from their recent spike after Iran's limited retaliatory strike on a US base in Qatar and the subsequent cease-fire with Israel.
Brent crude, which rose as much as 14% during the 12 days of the conflict, traded around $66 a barrel on Tuesday. The international benchmark was down 20% from last year's levels.
West Texas Intermediate crude, which rose as much as 10%, traded around $66 a barrel, down 18% year-over-year.
The oil spike needs to occur late in the business cycle. Oil price spikes that have occurred late in the business cycle have historically led to recessions, according to Morgan Stanley's analysis.
To be sure, while Morgan Stanley sees spiraling oil prices as highly negative for markets and the economy, such a scenario isn't analysts' base case.
"Through last week, the year-over-year rate of change on crude was negative. Thus, while we're respectful of the risks, there's a long way to go on this basis," strategists wrote.
The bank remains positive on stocks overall. While geopolitical events have historically sparked volatility in equities, the S&P 500 rose an average of 9% in the 12 months following major conflicts dating back to 1950, according to Morgan Stanley's analysis.
Prior to the cease-fire, other Wall Street forecasters were eyeing the risk of a more dramatic oil price spike and its potential effects on the US economy.
On Monday, JPMorgan analysts said they saw oil prices rising as high as $130 a barrel if conflict between Israel and Iran were to disrupt energy production in the Persian Gulf.
Torsten Sløk, the chief economist at Apollo Global Management, said he saw rising oil prices contributing to stagflation, a scenario where the economy slows while inflation remains stubbornly high.
"In short, higher oil prices exacerbate the ongoing stagflation shock stemming from tariffs and immigration restrictions," Sløk wrote in a June note to clients.
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