EYE ON THE  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

Lost in Space: The Search for Democratic in the Real World, and how I ended up halfway around the globe from where I began Executive Summary. With the first Democratic debate coming up this week, I thought it was a good time to share the following analysis. At the California Democratic Party Convention earlier this month, the former two- term Governor of Colorado was booed for saying that “socialism is not the answer”. The crowd has : recent surveys cite US college students having more favourable views of socialism than . When asked about failed 20th century socialist experiments, respondents insist they’re talking about instead. Fair enough, but before the world’s largest economy adopts democratic socialism, let’s see how it’s working out elsewhere. That’s where it gets murkier: such societies are not easy to find. Some point to as democratic socialism in action, but some Nordics object to this, such as Danish Prime Minister Rasmussen: "Some in the US associate the with some sort of socialism. Therefore, I would like to make one thing clear. is far from a socialist . Denmark is a "1. Our models back him up: while Nordic countries have higher and greater redistribution of , Nordics are just as -friendly as the US if not more so. Examples include greater business freedoms, freer trade, more and less of an impact on from state control over the economy. And as explained on page 6, while Nordics raise more taxes than the US, the gap usually results from regressive VAT/consumption taxes and Social Security taxes rather than from progressive income taxes. The bottom line: copy the Nordic model if you like, but understand that it entails a lot of capitalism and pro-business policies, a lot of taxation on middle class spending and wages, minimal reliance on corporate taxation and plenty of co-pays and deductibles in its healthcare system.

On many measures, the Nordic approach to the private sector is even more business-friendly than the US

Business-friendly policies Oligopolies State control (, licensing, trade, investment, real estate development) (all sectors, banks) (impact from gov't) 100

90

80

70 More concentration

60 More oligopolies (less competition) 50 Nordics 40 US 30 Business Starting a Free Trade Receptive to right Freedom of Economic Bank asset Competition Gov't impact State control of Freedoms business policies For Dir Inv protections flows concentration among firms on competition business

Sources: World Bank, OECD, , Fraser Institute, KOF Institute of Switzerland and WSJ. Y axis shows relative ranking on a 0-100 scale with 100 = highest rank except for bank asset concentration, which is measured as % of industry assets for the 5 largest banks. JPMAM, 2019.

Who pays for Nordic entitlement programs? Everyone, particularly the middle class Consumption, Social Security and Payroll Taxes as % of GDP Sw eden Netherlands Norw ay Denmark US 27.0 26.3 25.1 22.3 14.9 10.6 Source: OECD, 2018

1 Prime Minister Lars Lokke Rasmussen, Local.DK, November 1, 2015

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

With Nordic countries firmly rooted in capitalism and free markets, if I wanted to find examples of democratic socialism in practice, I’d have to look elsewhere. I broadened my search and looked for countries that, relative to the US, are characterized by2: • Higher personal and corporate rates, and higher • More worker protections restricting the ability of to hire and fire, and less flexibility for companies to set wages based on worker and/or to hire foreign labor • More reliance on , more constraints on real estate development, more anti-trust enforcement and more state intervention in product markets; and a shift away from a shareholder-centric business model • More protections for workers and domestic industries through tariff and non-tariff barriers, and more constraints on capital inflows and outflows I couldn’t find any country that ticked all these democratic socialist boxes, but I did find one that came close: Argentina, which has defaulted 7 times since its independence in 1816, which has seen the largest relative standard of living decline in the world since 1900, and which is on the brink of political and economic chaos again in 2019. Here my journey ended, halfway around the world from where it began. A real-life proof of concept for a successful democratic socialist society, like the Lost City of Atlantis, has yet to be found. Michael Cembalest JP Morgan Asset Management

Supporting charts and tables Nordic Countries: The Basics p3 Nordics: Market economies that are just as business-friendly as the US p4-5 Nordics: More taxation, with a heavy emphasis on taxation of middle class wages/spending p6 Nordics: More government spending, redistribution of income and worker protections p7-8 Argentina’s Fall from Grace, 1913 to 2018 p9

2 Sources include the World Bank, OECD, World Economic Forum, Fraser Institute, Swiss KOF Institute and WSJ.

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

Nordic countries: The Basics For this exercise, we define Nordic countries as , Finland, , Denmark and the Netherlands given common features of their economies3. Compared to the US, the average Nordic country is very small in terms of population and GDP, more closed to immigration, and very ethnically homogenous. Nordic per capita GDP was ~90% of US levels in both 1960 and 2018, so whatever model the Nordics adopted in the 1970’s, their relative wealth didn’t change much. Nordic countries rank high on surveys of and happiness; key differences vs the US include lower concerns about safety and security (see gun ownership rates below), lower defense spending (allows for more social programs) and lower concerns about environmental damage (Nordics rely more on renewable energy and nuclear power as a % of electricity generation and of primary energy use).

Population (millions) GDP (trillions) Ethnic homogeneity 350 $20 1.00 Total homogeneity 300 0.90 $15 250 0.80 200 0.70 $10 150 0.60 100 9 million $5 $500 billion 0.50 50 0.40 0 $0 0.30 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: Haver. 2018 Source: Haver. 2018 Source: Fearon (Stanford), Journal of Eco Gr.

Immigrant % of total population 1960 GDP per capita (thousands) 2018 GDP per capita (thousands) 16% $20 $65

15% $18 $60 90% of US 91% of US $55 14% $16 $50 13% $14 $45 12% $12 $40 11% $10 $35 10% $8 $30 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: United Nations. 2017. Source: Conference Board. 2018. Source: Conference Board. 2018.

Gun ownership per 100 persons Defense spending as % of total Renewable and nuclear energy 140 gov't spending 80% % of electr. % of primary 120 10% 70% 9% generation energy Nucl 100 8% 60% 80 7% 50% 6% 40% Nucl 60 5% 4% 30% 40 Nucl 3% 20% 20 2% 10% 1% Ren Ren Ren 0 0% 0% Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: Small Arms Survey, GIIDS. 2017. Source: SIPRI. 2018. Source: IRENA, BP. 2016.

3 We could have included , but since its population is only 330k and its GDP is roughly the same as Fort Wayne Indiana, we decided to leave it out. 3

EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

The Nordics: Market economies that are just as business-friendly as the US Nordic countries rank even higher than the US with respect to “Business Freedoms”, which include streamlined for new creation, and the ease and cost of obtaining licenses and real estate development permits. Nordic countries are also more open to free trade than the US (this was true even before Trump’s tariff barriers), are more open to foreign direct investment and apply fewer capital controls. Nordics also very protective of physical and intellectual property rights, and the adverse impact of Nordic government regulation on competition is lower than in the US4. Also, consider ways that Nordic countries are even more friendly to “management” than the US: Nordics allow more market dominance by large firms, and greater consolidation in banking. Furthermore, the US scores higher than Nordic countries with respect to overseeing management misuse of corporate assets (referred to as “Conflict of Interest Regulation”), which incorporates transparency of related party transactions, access to evidence and allocation of legal expenses in shareholder litigation.

Business Freedom Index Trading across borders Receptiveness to FDI (index, 100 = most pro-business) (index, 100 = most pro-trade) (index, 100 = most open) 90 100 95 85 95 90 80 90 85 85 75 80 80 75 70 75 70 65 70 65 60 65 60 60 55 55 55 50 50 50 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: WSJ, World Bank. 2018. Source: World Bank. 2018. Source: OECD. 2017.

Absence of capital controls Protecting property rights Gov't regulation impact on competition (index, higher = more impact from gov't regs) (index, 100 = no capital controls) (index, 100 = most protection for owners) 2.5 60 90 85 50 2.0 80 40 75 1.5 30 70 1.0 20 65 60 0.5 10 55 0 0.0 50 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: IMF. 2018. Source: World Bank. 2018. Source: OECD 2013. Competition among all firms Asset share of the 5 largest banks Conflict of interest regulation (index, 100 = most competitive) 100% (index, 100 = best conflict oversight) 85 80 90% 80% 80 75 70% 75 70 60% 50% 70 65 40% 65 30% 60 60 20% 55 10% 55 50 0% 50 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: World Economic Forum. 2018. Source: World Bank. 2018. Source: World Economic Forum. 2018.

4 Measured across energy, transport, water, telecom, professional services and retail distribution. 4

EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

Another sign that Nordic countries are not following a democratic socialist model: Nordic “state control” is similar to US levels. As part of its assessment of competitive forces, the OECD analyzes the extent of state control and government regulation. One method shows that Nordic governments exercise even less state control over the economy than the US, while another shows that over time, government regulation affecting competition in critical network sectors in Nordic countries has converged to US levels5. Either way, it’s clear from this data that the state control principles of democratic socialism (i.e., replacing private ownership with of the means of production) are very much at odds with the Nordic free-market model.

State control of the economy Competitive distortion induced by government regulation (index, higher = more state control) (index, higher = more distortion resulting from government controls) 3.1 5.5 Denmark 5.0 3.0 Sweden 4.5 Norway 2.9 4.0 Netherlands 2.8 3.5 Finland 3.0 United States 2.7 2.5 2.6 2.0 1.5 2.5 1.0 Nordic avg USA OECD avg 1990 1995 2000 2005 2010 Source: Public Ownership components of Product Source: Regulation in Energy, Transport and Communications (ETCR) Market Regulation State Control (PMR), OECD 2013. component of Non-Manufacturing Regulation Indicator (NMR), OECD. 2013.

Public Ownership components of OECD Product Energy, Transport and Communication component of OECD Non- Market Regulation State Control Indicator Manufacturing Regulation Indicator

● Share of 30 sectors in the economy in which the This measure covers seven network sectors (telecom, electricity, gas, state owns at least one firm mail, air transport, , and road transport):

● Extent of gov't ownership of the largest firms • Entry regulation: legal conditions concerning new market entrants, across six network sectors: electric, gas, rail legal limitations on the number of competitors allowed in the transport, air transport, postal service and telecom sector, terms and conditions for third party access, extent of choice ● Existence of gov't special voting rights in privately of suppliers for consumers, restrictiveness of licensing systems owned firms, and constraints on the sale of the • Public ownership: extent of gov't ownership in the largest energy, gov’t share of publicly controlled firms transport and communication firms ● Competitive advantage conveyed to state owned • Vertical Integration: degree of vertical separation between enterprises that is not available to private firms; different segments of rail transport and energy sectors insulation of SOEs from market discipline • Market Structure: a measure of de-facto competition assessing (for example) the market share of the largest company within a given sector, or the total market share of new entrants

5 The OECD’s PMR and ETCR indicators have been used by researchers to assess the impact of gov’t policies on the economy. For example, higher PMR/ETCR indicators are associated with abnormal and suboptimal persistence for certain firms, lower capital stock expansion and lower productivity growth. For the US, the PMR and ETCR are measured with respect to New York State. PMR indicators also portray EU countries as more regulation-intensive than they actually are, as they fail to fully take into account the benefit of streamlined regulations related to the EU internal market, according to Pelkmans (2010).

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

The Nordics: a higher tax burden, on everyone The Nordic tax burden is among the highest in the world, but to be clear, Nordic reliance on regressive VAT, Social Security and Payroll taxes accounts for much more of the tax revenue gap vs the US than progressive income taxes on households and corporations6. In other words, the Nordic model is highly reliant on taxing lower and middle class spending and wages. Note how corporate taxes contribute just 2%-3% of GDP in both the Nordics and the US, and how little Nordic countries rely on taxing capital gains of individuals, regardless of income levels. Finally, some Nordic estate tax rates are actually zero, with an average of 11% compared to US estate tax rates of 40%.

Total tax burden % of GDP Personal and corporate income Consumption, Social Security and 45% taxes % GDP (progressive) Payroll taxes % GDP (regressive) Other taxes 24% 24% 40% Cons/SocSec/Payr Taxes Payroll tax 35% 20% Personal inc taxes 20% Income taxes 30% SocSecur Tax 16% Corporate inc taxes 16% 25% Consump Tax 20% 12% 12% 15% 8% 8% 10% 4% 4% 5% 0% 0% 0% Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: OECD. 2017. Source: OECD. 2017. Source: OECD. 2017.

Taxes on earned income & capital Estate Tax on generational transfer gains of individuals, % of GDP 40% 16% Taxes on capital gains 35% 30% 12% Taxes on earned income 25% 20% 8% 15%

4% 10% 5% 0% 0% Nordic avg USA OECD avg Nordic avg USA OECD avg Source: OECD. 2017. Source: Tax Foundation. 2017.

6 Social Security taxes in the Netherlands and Denmark are based on a single rate applied up to an income cap (as in the US), or a fixed amount irrespective of income; such taxes are regressive. Other Nordic Social Security taxes apply a single fixed rate without a cap; these taxes are at best proportional, and not progressive. Furthermore, while personal income taxes in Norway/Netherlands are progressive (as in the US), in Sweden and Denmark, a flat municipal tax makes up a very large component of personal income taxes, substantially reducing their progressivity.

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

The Nordics: more government spending on healthcare and education, greater redistribution of income and more worker protections Higher Nordic tax revenues support more gov’t spending on programs such as state-sponsored healthcare and education. On healthcare, Nordic quality and access are among the highest in the world7. However, Nordic healthcare systems differ from US “Medicare for All” proposals: all five Nordic National Health Plans require patient co-payments (four of which are not contingent on the patient’s economic condition), and the three largest Nordic countries require deductibles before the gov’t pays for anything. This is consistent with a broader OECD trend of public plans shifting burdens onto patients. Furthermore, Nordic healthcare systems have extensive prescription drug guidelines, prescription tracking and volume monitoring, which often result in less plentiful and immediately available drugs compared to US Medicare.

Non-defense gov't spending % of % of population covered by gov't Healthcare Access/Quality Index GDP or social health insurance (index, 100=best) 50% 100% 96 45% 90% 94 40% 80% 35% 70% 92 30% 60% 25% 50% 90 20% 40% 88 15% 30% 10% 20% 86 5% 10% 0% 0% 84 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: WSJ, SIPRI. 2018. Source: OECD. 2017. Source: Global Disease Burden Project. 2016.

Cost-sharing and cost-containment policies in Nordic and US healthcare systems Does copay depend on socio- Patient deductible Prescription drug Prescription pattern and Use of copayment economic condition required guidelines volume monitoring Denmark Yes No Yes Yes Yes Finland Yes No No Yes Yes Netherlands Yes No Yes Yes Yes Norway Yes Yes No No Yes Sweden Yes No Yes Yes Yes US Medicare Yes No Yes No No Source: “Cost-Sharing Strategies Used within Publicly-Funded Drug Plans in the OECD ”, Manns et al, PLoS ONE, 2014

7 Access to healthcare services for diseases considered preventable (vaccine-preventable and infectious diseases; cancers, cardiovascular disease, and diabetes; and gastrointestinal conditions such as appendicitis).

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

On education, tuition costs at Nordic universities are ~10% of US public university costs, and even lower when compared to US private university costs. Nordic countries also provide workers with greater protections regarding the ease with which companies can hire/fire, set wages based on productivity, unilaterally set redundancy costs and hire foreign labor. Nordic unionization rates are much higher than in the US, and agreements are widely used across industries to a much greater degree. While Nordic countries have greater worker protections, Nordic workers earn a lower share of GDP than in the US. The Gini coefficient is one way to measure the extent to which Nordic countries redistribute income. While Nordic inequality of earned income isn’t that different than the US, once taxes and transfers are applied, Nordic inequality falls sharply. After the impact of taxes and transfers, Nordic Gini coefficients are among the lowest in the world, and their poverty rates are less than half of US levels.

% of university students enrolled Ease of hiring and firing Flexibility of wage determination in public institutions (index, 100 = easiest) (index, 100 = most flexible) 100% 90 90 90% 80 80 80% 70 70 70% 60 60 60% 50 50 50% 40 40 40% 30 30 30% 20% 20 20 10% 10 10 0% 0 0 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: OECD. 2016. Source: World Economic Forum. 2018. Source: World Economic Forum. 2018. Unionization rate Workers Rights Index Collective bargaining coverage rate 60% (index, 100 = highest labor protections) 90% 100 80% 50% Collective bargaining 90 70% 80 rights, right to strike, 40% rights to associate 60% 70 50% 30% 60 50 40% 20% 40 30% 30 20% 10% 20 10% 10 0% 0 0% Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: OECD. 2017. Source: World Economic Forum. 2018. Source: Int'l Labor Organization. 2016.

Labor share of GDP Poverty Rate GINI coefficient of income 20% 0.60 57% % of families Before taxes/transfers 0.55 56% with incomes After taxes/transfers 15% less than 50% 0.50 55% of median 0.45 54% 10% 0.40 53% 0.35 52% 5% 0.30 51% 0.25 50% 0% 0.20 Nordic avg USA OECD avg Nordic avg USA OECD avg Nordic avg USA OECD avg Source: In't Labor Organization. 2018. Source: OECD. 2018. Source: OECD. 2017. Higher = more unequal

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

Argentina’s fall from grace, 1913 to 2018 There are two ways to look at Argentina’s decline relative to the rest of the world since the early 1900’s. The first shows the ratio of real per capita GDP in 2018 vs the same measure in 1913. Argentina’s ratio barely rose, and is the lowest ratio of all countries for which data is available for both years.

Argentina's per capita GDP has barely doubled in over 100 years Ratio of real per capita GDP, 2018 vs 1913 45x

40x

35x

30x

25x

20x

15x

10x

5x

0x UK Iran Italy USA Peru India Chile Syria Brazil Spain Egypt China Japan Burma Ghana Turkey Ireland Jordan Austria France Algeria Poland Mexico Taiwan Tunisia Finland Greece Albania Norway Canada Belgium Sweden Vietnam Bulgaria Jamaica Portugal Hungary Uruguay Morocco Thailand Australia Malaysia Romania Denmark Germany Colombia Sri LankaSri Argentina Indonesia Singapore Venezuela Philippines Hong KongHong Switzerland Netherlands South Africa South Korea New ZealandNew Source: Conference Board, University of Groningen, J.P. Morgan Asset Management. 2018. The next method illustrates how Argentina used to be among the richest nations in the world, and how far it has fallen. The x axis shows percentile of per capita GDP in 1913, while the y axis shows the same measure in 2018. All countries below the diagonal line have seen their rankings fall, while those above the line have seen their rankings improve. The farther the distance from the diagonal line, the more things have changed; Argentina’s decline from the 83rd percentile in 1913 to the 40th in 2018 is the largest decline on the chart.

Reversals of fortune: changes in per capita GDP rankings since 1913 100% Singapore Norway Switzerland Hong Kong Ireland 90% United States Sweden Taiwan Netherlands Austria Germany Australia 80% Canada Denmark Finland Belgium Japan 70% France South Korea United Kingdom Italy New Zealand 60% Portugal Spain Malaysia Hungary Poland Greece 50% Turkey Uruguay Chile Romania Bulgaria Mexico Argentina 40% Iran Thailand China Brazil Algeria 30% Colombia Peru Indonesia Egypt Sri Lanka South Africa percentile of per capita GDP in 2018 GDP per of capita percentile 20% Tunisia India Albania Jordan Jamaica 10% Morocco Venezuela Vietnam Philippines Burma 0% Syria Ghana 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% percentile of per capita GDP in 1913 Source: Conference Board, University of Groningen, J.P. Morgan Asset Management

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019

Acronyms FDI: Foreign direct investment; GIIDS: Graduate Institute of International and Development Studies; ILO: International Labor Organization; IMF: International Monetary Fund; IRENA: International Renewable Energy Agency; SIPRI: Stockholm International Peace Research Institute; VAT: Added Tax

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EYE ON THE MARKET  MICHAEL CEMBALEST  J.P. MORGAN June 24, 2019 by us to you regarding such securities or instruments, including without limitation the delivery of a prospectus, term sheet or other offering document, is not intended by us as an offer to sell or a solicitation of an offer to buy any securities or instruments in any jurisdiction in which such an offer or a solicitation is unlawful. Furthermore, such securities or instruments may be subject to certain regulatory and/or contractual restrictions on subsequent transfer by you, and you are solely responsible for ascertaining and complying with such restrictions. To the extent this content makes reference to a fund, the Fund may not be publicly offered in any Latin American country, without previous registration of such fund´s securities in compliance with the laws of the corresponding jurisdiction. Public offering of any security, including the shares of the Fund, without previous registration at Brazilian Securities and Exchange Commission – CVM is completely prohibited. Some products or services contained in the materials might not be currently provided by the Brazilian and Mexican platforms. J.P. Morgan Chase Bank, N.A. (JPMCBNA) (ABN 43 074 112 011/AFS Licence No: 238367) is regulated by the Australian Securities and Investment Commission and the Australian Prudential Regulation Authority. Material provided by JPMCBNA in Australia is to “wholesale clients” only. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act 2001 (Cth). Please inform us if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future. JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under US laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future. This material has not been prepared specifically for Australian investors. It: • may contain references to dollar amounts which are not Australian dollars; • may contain financial information which is not prepared in accordance with Australian law or practices; • may not address risks associated with investment in foreign currency denominated investments; and • does not address Australian tax issues. References in this report to “J.P. Morgan” are to JPMorgan Chase & Co., its subsidiaries and affiliates worldwide. This material is intended for your personal use and should not be circulated to or used by any other person, or duplicated for non-personal use, without our permission. If you have any questions or no longer wish to receive these communications, please contact your J.P. Morgan representative. © 2019 JPMorgan Chase & Co. All rights reserved.

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