Go figure. With oil prices skidding in the past four weeks and down about 18% since their July peak, which is a clear boon to airline industry earnings, you would think airline stocks should be flying.

Not so; stock prices of the major airlines are sputtering. Despite lower fuel costs and improving bottom lines, many investors have become increasingly reluctant to board the shares of carriers this year, as evident by the industry’s tortoise-like 2006 stock crawl — a puny gain for the year of just 0.5%.

Not only that, airline stocks have performed poorly since early July, and not a single domestic carrier since then has outperformed the S&P 500. What’s more, the short interest in airline shares (a bet stock prices will fall) is said to be on the rise.

The dilemma, as explained by Morgan Stanley’s airline analyst William Greene: It’s not just fuel that counts, but macroeconomic matters. He recently cut his earnings estimates based on signs of decelerating revenue growth and also lowered the price targets on those carriers he follows by up to 27%.

Warren Buffett has described his past purchases of airline stocks as “temporary insanity.” Too bad, though, he didn’t buy them in recent years during which many airline stocks ballooned — some by as much as five- to ten-fold from their depressed lows of the early 2000s.

Why so? Because many airlines — thanks to restructurings and heavy cost-cutting — managed to escape the corporate graveyard after the industry was battered by bankruptcies, skyrocketing fuel costs, severe price wars, terrorism fears, and annoying changes in airport security that reduced air travel.

Now, though, given their mediocre 2006 showing, the shares seem to have run out of gas again, which flies in the face of the recent dip in oil prices and that a number of airline industry leaders are on the buy list of major brokerages and institutional biggies.

Morgan Stanley’s Mr. Greene offered some market perspective in a recent commentary sent to clients.The analyst covers just four stocks — AMR Corp. (the parent of American Airlines), Continental Airlines, JetBlue Airways and Southwest Airlines.

In the next 12 to 18 months, Mr. Greene views airline stocks (with strong reservations) as outperformers because of the strength of the cyclical upturn. Aside from outperformance, he thinks the four airlines he follows offer solid upside potential ranging from 18% to 29%, with JetBlue the biggest prospective gainer.

You might construe from such an enthusiastic market outlook that these are four stocks about which you ought to be excited. Not so, because Mr. Greene rates only one of them, JetBlue — a stock he thinks should be overweighted in portfolios — as an enticing investment. As for the other three, Southwest is viewed as a stock that should be underweighted, while AMR and Continental are viewed as equal weights (a normal weighting, and no big deal).

Further, he warns of individual risks for each of the four companies. For example, both AMR and Continental are felt to be at risk from continued growth of low-cost airlines in the domestic market. For JetBlue, there is said to be execution risk with respect to its turnaround. And Southwest is considered to be at risk from competitive capacity additions in its markets and challenging labor negotiations with its pilots.

Elaborating on his macro concerns, Mr. Greene notes that airlines have reported disappointing August traffic, citing heightened airport security as a key reason for weaker-than-expected demand. But the analyst raises the question of whether a decelerating American economy isn’t actually playing a bigger role. Mr. Greene has long believed that job growth is one of the primary drivers of demand in the airline industry, but he notes that recently it stalled out at just more than 1% and appears to be weakening.

Further, the Morgan Stanley Business Conditions Index, an indicator of business strength, registered its fourth consecutive sub-50% reading. Perhaps more significantly, Mr. Greene points out, the indices’ “hiring plans” component continued to weaken, as analysts reported a slight uptick in the number of companies they expect to cut payrolls. If indeed the MSBCI is an accurate indicator and business conditions keep deteriorating, Mr. Greene says he would expect airline revenue trends to weaken more meaningfully.

Yet another barometer used by the analyst to determine the health of corporate America is S&P 500 earnings growth. Based on research by Morgan Stanley’s strategy team, S&P 500 earnings growth trends have slowed substantially in the current quarter. Still another concern is capacity growth, which is expected to resume in 2007 and could cause airline unit revenue growth to slow faster than expected.

So while Mr. Greene views airline stocks as outperformers, his worries would seem to suggest investors should embark with caution.

In contrast, Merrill Lynch’s airline tracker, Michael Linenberg, given the rapidly declining fuel prices, has become more excited about the sector. As a result, he has revised upward his 2007 earnings estimates for AMR, Continental, and U.S.Airways and has upgraded his rating on each from neutral to buy.