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Economy & Markets

Surveying the Damage


Surveying the Damage: Russia’s recurring war on Ukraine, equity market declines and the opportunity for bottom-fishing investors, the energy price surge/recession outlook in Europe, the impact of rising metals prices on EV battery costs, the COVID situation in Hong Kong and the latest on ivermectin

Russia’s invasion of Ukraine is projected to result in one of the largest refugee crises in decades with 4-5 million people displaced 1;long-lasting water, air and ground pollution in Ukraine; and 90% of Ukraine’s population facing poverty and extreme economic hardship if the war drags on to the end of 20222.  For anyone surprised that Russia is imposing this brutal misery on Ukraine, don’t be: there’s ample precedent for it.  As shown below, the Holodomor famine imposed by Russia on Ukraine in the 1930’s dwarfs other famines in terms of severity and is another example of Russian subjugation of Ukraine by any means necessary3

Line chart which shows the mortality rate for historical famines. The chart includes the Ukraine Holodomor famine, the Ireland Potato famine, the North Korea Arduous March famine, the India Bengal famine and the China Great Leap Forward famine. The chart shows that the Holodomor famine resulted in a much higher death rate per 1,000 people than other famines.
As I wrote in the last two notes, I’m dubious of Europe’s ability to sharply reduce reliance on Russian energy given the need for rapid LNG build-outs, wind/solar/heat pump adoption that’s way above trend, non-existent hydrogen infrastructure and maximizing nuclear.  But if Europe pulled it off, Russia’s share of world GDP would shrink further (see chart) at which point it could essentially turn into an energy vassal state for China.  China has been Russia’s largest trading partner for over a decade, while Russia accounts for just 2% of Chinese exports.
Line chart which shows Russia/USSR share of World GDP since 1820. The chart shows that Russia’s current GDP represents a significantly smaller portion of global GDP than peak USSR shares in the 1950s and even Russia’s share during the early 1990s.
Line chart which shows net imports of oil, natural gas and coal in million tonnes of oil equivalent for Europe, China, the US and Russia. The chart shows that China and Europe are large net importers of energy while Russia is a large exporter.

The first chart sends a consistent message on US equities4: a large correction took place, and if there is no US recession, the March 8th low was probably a market bottom as it is similar in magnitude to other large selloffs.  If there is a US recession, the average stock decline from peak levels suggests further downside.  I consider recession risk to be a close call given rising energy prices, rising credit spreads, rising wages, supply shortages that are now exacerbated by the war and a rapid about-face from the Fed designed to cool things down via higher interest rates (including one or more 50 basis point hikes this year).  But I believe the US will make it through without a recession.  The second chart is another barometer for bottom-fishing investors: it shows how the average stock sold off much more sharply than its respective index.  Since March 8th, the US equity indices shown below have risen by 6%-9%.

Bar chart which shows the history of market drawdowns. The chart shows the average stock market decline during recessions and other large sell-offs compared to the March 8, 2022 drawdown. While US indices are 20-45% below their prior peaks, none of the indices have fallen as much as the average recession.
Bar chart which compares market drawdowns versus their constituents. The chart includes a bar for the entire index, the median stock and the average stock. The chart illustrates how the average and median stock have fallen significantly more than the broader indexes.
While there has been a lot of damage done to the average stock, the P/E ratio of the 25 stocks with the largest market cap is still elevated compared to history, a reflection of investor confidence in the earnings resilience of these companies5.  And while hedge fund leverage has come down, it has not collapsed as much as it usually does during recessions.    As for institutional long-only asset managers, CFTC futures positions in the S&P 500 and NASDAQ are not quite at 2018 and 2020 lows but are approaching them, while small cap futures positions are now at the lowest levels since the 2008 financial crisis.
Line chart which plots the P/E ratio of the top 25 stocks in the S&P 500 versus the rest of the market. The chart shows that the largest companies have elevated relative valuations compared to history.
Line chart shows the decline in hedge fund gross leverage, which recently fell to the lowest level since the economy recovered in early 2021.
Similar conclusions can be drawn from credit spreads: while spreads have widened, they are nowhere near levels typically seen during recessions.
Line chart shows the high yield credit spreads in both the US and emerging market since 1987 and 1997. The chart shows that both credit spreads have widened at relatively the same pace. However, spreads are nowhere near levels seen in previous recessions (i.e., 2020, 2008, etc.)
Line chart shows the US investment grade credit spreads since 1987. The chart shows that credit spreads have widened recently. However, the spreads are well below previous levels seen in recessions (i.e., 2020, 2008, etc.)
In contrast, the selloff in China (particularly in the internet sector) is pricing in a lot of adverse news.  Investors should now assume the elimination of all Chinese ADRs and higher costs of capital for Chinese companies, and the lockdowns in Shenzhen and Shanghai are tougher than I expected they would be.  However, China has tightened monetary, fiscal and regulatory conditions for the last year and a half, and now has a larger reservoir of stimulus ammunition if they choose to use it.  I think they will, since the Communist Party leadership established a 5.5% growth target for this year.
Line chart shows a comparison between the return on the NASDAQ from 1999 to 2004 and China internet stocks since Sept. 2019. The chart shows that the China internet correction is close to matching the drawdown of the NASDAQ post-tech bubble.
Line chart shows that the MSCI China equity index is down 45% from its peak

Europe is one of the most efficient places on earth regarding energy consumed per unit of GDP (see first chart). Unfortunately, current energy and other producer price increases in Europe are so large as to overwhelm most energy efficiency gains. This has been a large commodity shock: a basket of energy, industry and precious metals, agriculture and livestock is up ~80% since the fall of 2019, similar to the commodity price shocks during the 1973/1974 OPEC oil embargo era and the second oil shock in 1979/1980.

As shown below, European electricity and natural gas prices have quadrupled.  In addition, Europe is facing a massive producer price shock: the second chart shows the gap between producer and consumer prices.  At some point, the surge in producer prices in Europe either gets absorbed by companies through lower margins, reduced hiring and less capital spending, or it gets passed on to consumers, triggering higher CPI and tighter policy from central banks.  Since 1948 when the data begins, the US has not experienced anything like the producer price shock that Europe is experiencing now.  It looks like a recession in Europe will be the inevitable result.  European equities are priced at ~13x with earnings expected to be flat in 2022; during European recessions, earnings can fall 25% with P/E ratios falling below 10x.  So, it’s hard to argue that Europe is very good value here unless there is an unexpectedly quick end to the Russian invasion of Ukraine.

Bar chart shows the energy intensity by each country, measured by energy consumed per unit of GDP. The chart shows Europe is one of the most efficient places, in comparison to other countries like Canada, China, US, Brazil, and India.
Line chart shows the gap between the producer price inflation index and the consumer price inflation index for the US versus Europe. The US has not experienced anything like the producer price shock that Europe is experiencing now, with the gap between PPI and CPI at about 25%.
Line chart which shows wholesale electricity prices for the UK, US and an average of Germany, Spain and France prices. Prices in Europe have risen to extreme levels in 2021 and 2022, and remain at levels between $200 and $250 per MWh of electricity. In contrast, US prices have stayed between $30 and $50 per MWh.
Line chart shows wholesale natural gas prices for Europe and the UK vs the US. Prices in the UK and Europe have risen to extreme levels in 2021 and 2022, and remain at levels around $30 per MMBTU. In contrast, US prices have remained around $5 per MMBTU.

There are wild short squeezes and mayhem reportedly taking place in nickel markets, so current price levels may not last long.  But if metals price increases since early 2020 are sustained, what could happen to EV prices due to rising battery costs?  Using metals composition of EV batteries from Argonne National Labs and the latest metals prices (including an assumed post-squeeze decline in nickel prices to $26,500 per metric ton), I took a look. I analyzed a hypothetical 60 kWh battery across three chemistry types: Lithium Nickel Manganese Cobalt (NMC), Lithium Nickel Cobalt Aluminum (NCA) and Lithium Iron Phosphate (LFP).  The table shows battery chemistry by auto manufacturer; LFP batteries are used by Tesla and Chinese EV makers, while the rest mostly use NMC at least for now.  LFP batteries are typically cheaper but have lower energy densities.   China manufactures most LFP batteries while Samsung and LG Chem produce most NMC batteries.

Estimated LFP battery costs have risen by ~$500 since January 2020, mostly due to rising copper prices; this increase seems manageable as a % of vehicle cost.  In contrast, estimated NMC and NCA battery costs increased by ~$1,500 since January 2020 with a large part of that increase occurring this year due to rising nickel and cobalt prices.  For all EVs, there could be another $500 EV cost increase due to incremental copper and aluminum used for non-battery purposes in excess of amounts needed in internal combustion engine cars.

The bottom line:  there may be some sticker shock for EVs reliant on nickel and cobalt, but not for EVs using LFP chemistry.   Of course, EV owners would save even more on fuel if the gap between gasoline and electricity costs per mile is sustained 6 I’ve been a skeptic on US EV adoption rates (just 2% of sales last year), and now there’s another headwind that NMC-EVs face that might require even more generous Federal subsidies. 


Line chart shows the cost of metals per $60 kWh electric vehicle battery. Metal costs for NMC and NCA batteries have risen from around $1,000 per battery in January of 2020 to between $3,000 and $3,500 in 2022. Metal costs for LFP batteries have risen from around $500 to just above $1,000 per battery.
Bar chart shows the battery cost breakdown by material for NMV, NCA and LFP EV batteries. Nickel and Cobalt account for a large portion of NMC and NCA costs. In contrast, LFP batteries do not use nickel or cobalt, and total costs are much lower as a result.
Line chart shows metal prices indexed to December 2019. Lithium, Manganese, nickel, cobalt and aluminum prices have risen 2-6x from then to 2022.

I wrote in February about a market research firm I subscribe to whose principal researcher does not believe in the efficacy of COVID vaccines.  Their founders are French but are based in Hong Kong given what they often criticize as creeping French government control of industry (yes, the ironies are too numerous to mention).  In any case, if his vaccine skepticism is influenced by the situation in Hong Kong, he should take a closer look.

Current Hong Kong COVID mortality rates are ~4x peak US levels which took place last year. There are two primary reasons for this, in my view.  First, as shown in the table, for some strange reason, vaccination rates in Hong Kong are inverted relative to risk (age).  In other words, middle aged people are vaccinated at a much higher rate than older people.  Second, around half of the people in Hong Kong are vaccinated with CoronaVac, a vaccine produced by Beijing-based Sinovac.  Among those over 80, CoronaVac is only 45% effective against mortality7. I don’t have a direct comparison for 80+, but the latest mRNA vaccine efficacy metric for the 65+ US population is 70%-80% according to Oakland’s Public Health Institute. 

China is reportedly working on its own mRNA vaccine which is still in Phase III trials. One such Chinese company was added to the US Federal Trade restricted list given its alleged use of biotechnology to support activities such as “brain control weaponry” (!!). Separately, BioNTech and its Chinese partner have completed their own trials but their mRNA vaccine has not been approved yet by Chinese authorities. 

Line chart shows COVID mortality in Honk Kong, Korea and the US from August 2020 to now. Current Hong Kong COVID mortality rates are ~4x peak US levels, which took place last year, and are well above mortality levels in Korea.

The latest on ivermectin: “Neigh”, says Mister Ed

A recent clinical trial in Brazil evaluated the effects of ivermectin when administered to those who tested positive for COVID and were at risk of severe disease. Half of the ~1,400 patients were prescribed ivermectin for three days, and then tracked for 28 days to determine whether they were hospitalized and if they cleared the virus faster than patients who received placebo pills. The trial concluded that ivermectin did not improve patient outcomes, either in terms of reduced hospitalizations or increased speed of recovery8.

As a reminder: ivermectin is a horse de-worming drug but is also a very effective drug for humans infected with certain parasites (its creators won the Nobel Prize for it in 2015).  When used for parasitic treatment, ivermectin is given as a one-time dose; the “ivermectin for COVID” crowd are often taking it twice a week even though there is no safety data on prolonged use. 

None of my analysts understood the Mister Ed reference since they did not know who he was.  The cultural divide between my generation and theirs is unbridgeable.  Maybe it’s time for me to be put out to pasture.

1 This 4-5 million figure for Ukraine refugees compares to the following from the UN High Commissioner for Refugees: Syria 6.7 mm, Venezuela 4.0 mm, Afghanistan 2.6 mm, South Sudan 2.2 mm and Myanmar 1.1 mm

2UN Development Program press release, March 16, 2022

3See “Mass Repression and Political Loyalty: Evidence from Stalin's Terror by Hunger”, Rosenas (NYU) and Zhukov (University of Michigan), 2019 and Anne Applebaum’s “Red Famine” (2017)

 4Charts sourced from JP Morgan Global Markets Strategy, March 17 Equity Market Update

5The largest 5 stocks are now Apple, Microsoft, Google, Amazon and Tesla.  The remainder are comprised of large cap pharma/biotech, mega-banks, specialty retail, interactive media, food/beverage and even some energy companies.

6Assuming 25 mpg for a gasoline car, 3 miles per kWh for an EV, $4 gasoline, 14 cents per kWh for electricity and 11,000 miles driven per year, EV owners would save ~$1,250 per year in fuel expenses.  Comparing this annual amount to the incremental upfront cost of an EV over a gasoline car yields the payback period.

China’s COVID vaccines have been crucial – now immunity is waning”, Mallapaty (Nature), October 14, 2021.

8TOGETHER trial, Edward Mills (McMaster University) and Craig Rayner (Monash University), March 2022

Listen to the Podcast


FEMALE VOICE:  This podcast has been prepared exclusively for institutional, wholesale, professional clients, and qualified investors only as defined by local laws and regulations.  Please read other important information, which can be found on the link at the end of the podcast episode.

MR. MICHAEL CEMBALEST:  Good morning everybody, this is the late March Eye on the Market podcast.  Topics this week all have to do with surveying the damage, surveying the damage from Russia’s war on Ukraine, surveying the damage to equity markets and some bottom-fishing opportunities for investors, surveying the recession outlook in Europe due to rising energy prices, surveying the impact of rising metals prices on EV battery costs, and surveying the damage in Hong Kong from the COVID situation. 

     So I just want to start for a minute on Russia’s invasion of Ukraine.  This is creating one of the largest refugee crises in decades.  There’s going to be some long-lasting water, air, and ground pollution in Ukraine, and 90% of the people that live there could face poverty or hardship by the end of the year. 

If anybody is surprised that Russia is imposing this kind of misery on Ukraine, you shouldn’t be.  There’s ample precedent for it.  We spent some time looking through the history of famines.  And the famine imposed by Russia on Ukraine for political reasons in the 1930s dwarfs other famines in terms of severity and is a previous example of Russian subjugation of the Ukraine by any means necessary. 

It’s kind of remarkable to see this chart.  The death rate from the Russian-imposed famine on the Ukraine dwarfs the Irish potato famine, the North Korean famine, famines in India, and even the Great Leap Forward famine in China in the late 1950s.  Larger numbers of people died in China from that famine, but on a rate per thousand people, the Ukraine famine imposed by Russia was the worst one. 

So as we wrote in the last two notes, I’m dubious of Europe’s ability to sharply reduce its energy reliance on Russia.  I mean the things that would need to be done, rapid LNG buildouts of gasification of liquid faction facilities, solar, wind, and heat pump adoption that’s way above trend, exploiting non-existent hydrogen infrastructure and rebuilding or regaining access to shuttered nuclear facilities, all those things are very difficult to do.  But if Russia pulled it off, but if Europe were able to pull this off, Russia’s share of world GDP would shrink even further below the roughly 2% level that it’s at now.  We have a chart in here that shows Russia and the USSR share of world GDP since 1820.  And without European purchases of Russian energy, Russia could easily just turn into a vassal state that provides energy just to China.

In terms of surveying the damage to equity markets, there was a bunch of research that was done by J.P. Morgan’s investment bank last week, and I thought it was pretty good, so I replicated some of it here.  The charts all send a consistent message.  There was a very large selloff that took place.  And if there’s no recession in the United States, the March 8th low is probably the bottom.  If there is a recession, the average stock market decline would suggest further downside. 

But I consider the recession call to be a close one.  I still think the US will make it through without a recession.  For sure growth is going to take a hit, energy prices are going up, credit spreads, wages, supply shortages, and rising interest rates.  There’s no question that housing is going to slow markedly.  But something in the neighborhood of 1.5 to 2% seems like the kind of growth shock the US will experience here.  And if that’s the case, March 8th may have been the bottom for this particular selloff. 

And the opportunities in individual stocks are even more pronounced at the index level for a lot of large and small-cap, and NASDAQ stocks are down 35, 40, 50, 60% way more than the indexes themselves.  And hedge fund leverages come down; futures positions of long-only asset managers have come down.  So most of the signals that we look at have come down.  The only thing that hasn’t come down that much is the PE ratio of the 25 largest stocks in the market.  The mega-cap stocks, of course the valuations have declined but are still expensive on any kind of historical basis.  So for anybody looking to do bottom fishing, it looks like the opportunities are outside those mega-cap names.

We’ve got some information here on credit spreads as well.  Similar message, while spreads have widened, they are nowhere near the levels that are seen during recessions.  Now if you are really interested in aggressive bottom fishing, the Chinese equity markets are pricing in probably more bad news than any place.  There’s a chart that we show here that tracks the China Internet Index, kind of looks like the NASDAQ from 1999 to 2004. 

The Chinese equity drawdowns have been pretty severe.  They have been tightening monetary, fiscal, and regulatory conditions for the last year and a half.  So they’ve got some accumulated stimulus ammunition if they choose to use it.  And I think they will since the Communist party has established around a 5.5% growth target for the year, and I don’t see how they’re going to reach that unless they start to deploy some stimulus.  So in addition to some of the beaten down names in US markets for the intrepid, there appear to be some opportunities in China as well, although it would probably take 18 to 24 months to figure out after the fact if that made any sense. 

One place I would not be tempted to bottom fish is Europe.  Europe is almost certainly headed for recession.  Now Europe is one of the most energy-efficient places on earth if you look at energy consumed per unit of GDP.  Europe in general is lower than China, lower than the US, lower than Canada, lower than Japan.  Europe is a very energy-efficient place per unit of growth.  Unfortunately, the commodity price shock has been so huge that it’s overwhelmed the benefit of those energy efficiencies.  And no matter how energy efficient you are, if electricity and natural gas prices are going to quadruple, you’re going to have a problem.  And that’s what’s happened in Europe. 

They’re also facing a massive, massive producer price shock.  And there’s a chart in here that shows that producer prices have soared something like 25% higher than consumer prices.  In other words, that gap has to go somewhere.  So either companies are going to take a huge hit in terms of declining margins, hiring, and capital spending, or they’re going to have to pass that onto consumers and trigger higher CPI and tighter policy from the ECB. 

So I look back to 1950.  The US has never experienced anything like the producer price shock that Europe is experiencing right now.  And the recession in Europe is likely to be the inevitable result.  Europe has sold off.  It’s priced at about 13 times earnings, with earnings expected to be flat this year.  But during European recessions, earnings can fall 25%, and PE ratios can fall below 10.  So it’s hard to argue that Europe’s a good value here unless there’s an unexpectedly quick end to the conflict in Ukraine. 

We’ll go into more of the details in the energy paper later this year.  But one of the consequences of Russia’s invasion has been a surge in metals prices.  Everything from lithium to nickel, aluminum, copper, iron, steel have all gone up by 50% or 250% since January 2020.  And there’s this page in this week’s Eye on the Market that looks at the impact on theoretical battery prices for electric vehicles and how those increased metals prices would eventually feed through - -.  And we look at different auto manufacturers, different battery compositions, and there are some big differences there.  For example, Tesla in China use a lithium ion phosphate battery that does not have nickel and cobalt in it.  So those battery prices haven’t gone up as much as they have for some of the other auto manufacturers. 

The bottom line is that depending upon the battery chemistry, the metals prices have created either a $500 or $2,500 increase in the estimated economic cost of a vehicle.  And maybe plus a few hundred dollars more for incremental copper and aluminum that has nothing to do with the battery, but gets used a lot in EVs compared to traditional cars. 

So another headwind essentially for EV adoption.  Of course most EV owners could expect to save a lot of fuel costs if gasoline and electricity prices stay where they are.  Using some standard assumptions on mileage, miles driven, electricity costs, gasoline costs, EV owners would typically save somewhere between 1,000 and $1,500 a year in fuel expenses.  So if you compare that to the incremental cost of an EV up front over a gasoline car, you can figure out the payback period. 

But the bottom line is that there has been for some of the EVs, the ones that use the nickel, manganese, cobalt oxide battery approach, there’s been a bit of a price shock here that might have to be addressed through even more general, generous federal subsidies in both the US and in Europe in order for those EV adoption rates to stay on trend. 

The last two topics this week have to do with COVID.  One of the big shock, I mean the chart here, you just have to see it to be believe it, for the last two years, Hong Kong COVID mortality was basically nonexistent.  We didn’t even plot it because it was so close to zero.  And now the COVID mortality rate in Hong Kong has soared and is now around four times higher than the peak mortality rate in the US that took place a little over a year ago, which is wild. 

So how do you explain this?  Well to me, I think there’s two factors going on.  First, for some reason, and no one’s been able to explain to me, vaccination rates in Hong Kong are inverted relative to age.  In other words, the middle-aged people are vaccinated at a much higher rate of about 90 to 93%, and it drops all the way to 35% for people 80-plus.  So how do you end up with a public health service that does that?  It’s very strange. 

Second, about half the people in Hong Kong are vaccinated with CoronaVac, which is a vaccine produced by a Chinese company called Sinovac.  According to some research we’ve seen, CoronaVac’s only 45% effective against mortality, which is 30 to 40% lower than the efficacy rates seen for the mRNA vaccines.  So low vaccination rates of old people and less effective vaccines explain part of it.  But I don’t know that I would be able to explain all of it given the increasingly difficult information flow issues going on in Hong Kong and China as well.

So China is reportedly working on its own mRNA vaccine, still in phase three trials.  Interestingly, one of the companies involved was added to the US federal trade restricted list given its alleged use of biotechnology to support brain control weaponry.  So it’s a strange world that we live in. 

Last quick COVID topic for the week is on ivermectin.  You’re probably aware of ivermectin.  It’s often used as a horse deworming drug but is also an effective drug used for humans that get infected with certain parasites.  The thing is when it gets used for parasitic treatment, it’s given as a one-time dose.  And the people using it for COVID are taking it twice a week, even though there’s absolutely no safety data on that kind of protocol. 

Anyway, so a recent clinical trial in Brazil evaluated ivermectin versus a placebo and found absolutely no benefit in terms of patient outcomes of reduced hospitalizations or increased speed of recovery.  So I was willing to be open-minded about it pending a broad study.  But now that one’s been completed, I think we have the answer that ivermectin is not super-helpful.  And so I mentioned to my team that the verdict should be described as a neigh from Mr. Ed.  They completely didn’t know who Mr. Ed was, which is maybe a sign that it’s getting close for me to think about retirement.  Anyway, thank you very much for listening, and I’ll talk to you next time, thank you.      

FEMALE VOICE:  Michael Cembalest’s Eye on the Market offers a unique perspective on the economy, current events, markets, and investment portfolios and is a production of J.P. Morgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for J.P. Morgan Asset Management and is one of our most renowned and provocative speakers. 

For more information, please subscribe to the Eye on the Market by contacting your J.P. Morgan representative.  If you’d like to hear more, please explore episodes on iTunes or on our website.  This podcast is intended for informational purposes only and is a communication on behalf of J.P. Morgan Institutional Investments Incorporated.  Views may not be suitable for all investors and are not intended as personal investment advice or a solicitation or recommendation.  Outlooks and past performance are never guarantees of future results.  This is not investment research.  Please read other important information, which can be found at www.JPMorgan.com/disclaimer-EOTM.  


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