• Democratic presidential nominee Joe Biden's shrinking lead in betting markets suggests a contested election is becoming more likely, JPMorgan strategists said Tuesday.
  • A higher chance of a contested or close election outcome would slam the bank's expectations for fresh stimulus and "likely put some downward pressure on risk markets for the near term," the team wrote in a note to clients.
  • A close result could also yield a split Congress and prolong the months-long stimulus stalemate. 
  • Long-term strategies should allocate 40% of their portfolios to stocks, the team added, as upside for equities depends on central bank asset purchases.
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Markets might be too quick to price in a Biden presidency, JPMorgan strategists said Tuesday.

Democratic presidential nominee Joe Biden maintained a steady lead in the polls in recent weeks, leading many firms to adjust expectations for 2021 stimulus, tax policy, and Congressional makeup. Yet betting markets are now reversing course and point to a narrowing lead for the former vice president.

The shrinking gap suggests the odds of a contested election are increasing, as President Donald Trump has already indicated he may avoid conceding the race if margins are relatively close in key states.

A higher chance of a contested result would cut into hopes for new stimulus and "likely put some downward pressure on risk markets for the near term," the team led by Nikolaos Panigirtzoglou wrote 

To be sure, many have already pushed back projections for fresh fiscal support. House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin remain locked in negotiations, aiming to reach a stimulus compromise before the end of the week and pass a bill before Election Day. Yet Senate Republicans back their own much smaller proposal, setting up each party to block the other's measures.

The stalemate led many strategists to look ahead to Election Day and its potential outcomes. Wall Street largely agrees that a Democratic sweep of the White House and Senate would create the path of least resistance for a large stimulus deal. A divided government would likely prolong the legislative deadlock and yield a smaller bill.

Biden's contracting lead suggests the election, contested or not, is more likely to result in a split Congress, JPMorgan said. Such an outcome would hamper the value trade, the bank's strategists added, as more cyclical sectors wouldn't enjoy the stimulus boost some expected.

While US stocks might face some vulnerability in the short run, the team recommends a roughly 40% equity allocation for longer-term strategies. Upside in the stock market depends more on debt and liquidity creation than on fiscal stimulus, the strategists said. In turn, investors should pay more attention to the Federal Reserve's asset purchase plans for market insight, according to the bank.

Another relief bill could aid stocks, but only to the extent that it widens investor concentration to include cyclical sectors and value names, the team added.