* Expects U.S.-China trade spat to end in compromise
* Sees higher market volatility due to political risks
* Remains overweight on U.S. stocks, prefers small/mid-caps
By Tomo Uetake
TOKYO, April 9 (Reuters) - Principal Global Investors bought U.S. shares on recent market dips as the asset management firm saw the U.S. economy chugging along in spite of worries about a trade war, Chief Executive Jim McCaughan said on Monday.
McCaughan said the ongoing trade spat between the United States and China is likely to ultimately lead to a compromise, rather than a full-scale trade war.
"Most likely, you get concessions, you get a face-saving compromise and both can declare a victory," McCaughan told Reuters in an interview, but warned that the risk of a trade war was not negligible.
"It's more serious than a 'tail risk,' which is usually a 5 percent probability or less... Diversification can act as a counter balance," he said.
Headline risks stemming from a potential U.S.-China trade war and geopolitical tensions on the Korean Peninsula and Iran could lead to higher market volatility, said McCaughan, estimating an about 20-30 percent negative tail risk.
"In many of our strategies, we have a strategic allocation and we'll rebalance when they get out of whack. So weakness in equities would tend to make us a buyer," he said.
"In terms of volatility, markets so far this year have actually been more like the markets in the 80s and 90s. Back then, 1 percent move (in a day) was pretty common. Those days were back."
Despite the market volatility, McCaughan expects U.S. economy to continue to grow between 2-3 percent with inflation well-contained around 2 percent in the next three years.
He expects only one more U.S. interest rate increase by the Federal Reserve this year, while many market participants estimate two to three rate raises.
"On a 70 or 80 percent probability, you'll probably see equities going up and you'll see bond yields stay pretty close to the current levels, maybe go up a little bit. My best guess of the 10 year treasury yield, a year from now, is 2.80 percent."
PGI is the asset management arm of Principal Financial Group, headquartered in Des Moines, Iowa, and had $454 billion in assets under management as of Dec. 31.
"We have been quite bullish of U.S. equities for a number of years. That has paid off well, and we'll continue to do so. Our favourite areas will be small- and mid-cap U.S. equities," McCaughan said. (Reporting by Tomo Uetake; Editing by Amrutha Gayathri)