(FORTUNE Magazine) – Just six months ago Charles Clough (rhymes with how) came aboard as chief investment strategist for Merrill Lynch, where he counsels over 11,000 retail brokers and 440 institutional brokers at the nation's largest wire house. That * kind of responsibility can weigh heavily. But Clough, 45, formerly a highly regarded seer at Cowen & Co. in Boston, maintains a warm, amicable demeanor -- in keeping with his other role as an ordained Roman Catholic deacon who is assigned to Our Lady Help of Christians parish in his hometown of Concord, Massachusetts. ''To be really successful in your business life,'' he says, ''there has to be another dimension to your humanity.'' In a recent interview with FORTUNE's Andrew Serwer, Clough stuck to worldly matters, discussing stocks that still look good.

Where is the market headed? A fair answer might be, I don't know. But there are some important signals we can look at. First, stocks have historically given investors an average yearly return of 10%, counting reinvested dividends. When the interest rate on long-term Treasury bonds approaches that level, as it did recently, you see money flow out of stocks and into bonds. Second, I think we are seeing a real pickup in the industrial economy, which will drain liquidity from the financial markets. So those are two strikes against the market. At this stage of the game, the market tends to be volatile, and advances tend to be narrow. An invested portfolio has to be sitting on stocks with strong earnings trends. We see a good possibility that the market will be down, say 15%, over the next 12 months. The Dow could rise, but it would be a very narrow advance, with only certain stocks participating.

Like which ones? We look at the market in terms of three large groups -- consumer, financial, and industrial stocks. We are convinced that financial stocks, particularly those of savings and loan institutions and certain banks, entered a bear market about a year ago and still have a way to fall. These companies did extremely well in the 1980s, but that attracted competition, which has narrowed profit margins. In the consumer sector, we are finally seeing a slowdown. You can see that in the problems specialty retailers like the Gap are having. I think we are going to see the real earnings gains come from the industrial sector.

So you don't recommend any consumer or financial service stocks? First, let me point out that many of these stocks look very cheap, but that's only because their earnings estimates are too high. They will have to be revised downward. Having said that, there are some stocks in these groups we like. These include companies with an unassailable position where the markets are vast, like McDonald's, Coca-Cola, and Anheuser-Busch. We like certain drug stocks like Marion Labs.

What do the industrials have going for them? We are in the beginning of a fairly durable, long-lived recovery. The deflation of the 1980s overshot on the downside. With deflation came a dramatic drop in industrial materials prices. Companies liquidated inventory, which created the perception that we had excess factory capacity. That virtually wiped out capital spending. What we are seeing today is a gradual reemergence of investment in the industrial sector. The catalyst was the declining dollar, which has made the U.S. the productive site of preference in the developed world today. All kinds of industrial stocks have begun to benefit.

Does that include natural resource stocks? Actually, we think many stocks, such as those in the paper, chemical, and mineral industries, have already run up. I like machinery makers such as Cooper Industries, Parker Hannifin, Caterpillar, and Imo Delaval. We expect these companies to show substantial earnings gains.

But haven't those stocks also moved up? Over the past six months, yes. Compared with prices of eight years ago, no. Over the long term these stocks have a ways to go.

What other stocks will benefit? We like many stocks in the technology group. When Ford builds a new engine plant, there are going to be a lot of computer terminals on the floor. I think in this situation a company will buy quality equipment, so the big names will be the beneficiaries -- manufacturers like IBM, Hewlett-Packard, Unisys, and NCR. Apple and Compaq may have a strong earnings future, but the stocks have gotten a little ahead of themselves. We think a new computer cycle is starting to move. One question is the extent to which IBM will participate. We think it will, slowly. We think it will be a better stock in 1988 than this year, sort of like the Boston Red Sox should be a better team next year. We like the leading chipmakers, Intel, National Semiconductor, and Texas Instruments.

Any transportation stocks? We favor railroads over truckers and airlines. Rail stocks move with the industrial economy. They sell for modest price-to-book-value ratios, and we could see some earnings surprises once the economy picks up. We like CSX and Union Pacific.

You also like defense stocks. Isn't the buildup over? $ We are clearly sitting on the top of a major defense spending cycle, which tends to span decades, so we don't think you will see the emergence of a new cycle. We do see continued growth in the defense electronics area. If we sign some sort of missile control agreement with the Soviet Union, surveillance spending will continue to pick up. Companies with a specialty niche like Raytheon, Martin Marietta, and E-Systems will profit.