In the wee hours of this morning, analysts Jamie Baker and Mark Streeter of JP Morgan issued a huge upgrade of the airline sector. Not only were airline stocks upgraded, but the investment bank also upped its recommendation on airline credit.

From their research note this morning:

“We do not believe equities (or credit for that matter) have sufficiently responded to sharply lower fuel prices and resulting likelihood of profit resumption in 2009. Given the combination of improved non-fuel fundamentals, bolstered liquidity for many, and equity values meaningfully below March levels, we are significantly revising our estimates and equity/credit ratings for North American airlines.”

The two then went on to explain:

“This Isn’t Just An Oil Call – Jet kero prices have plummeted over $1/gallon from recent highs, representing $13 billion of reduced annualized expense. This represents both the most rapid and most significant expense savings ever realized for the airlines, standing well in excess of any historic precedent for demand weakness.

The Industry Has Also Changed – This isn’t the same industry that gave us pause last March. Annualized system capacity cuts have reached 8%, liquidity defenses have been bolstered for many, other revenue trends (bag fees, etc) are surging, one merger appears set to close . . . and the sell side largely has settled into a period of uncharacteristic bearishness.

Best Yet, Equities Are Down – Sure, equities haven’t ignored oil’s descent. But many Legacy equities are still well below their March levels despite the aforementioned fundamental changes. Continental is 22% lower, Delta 23% lower, United 54% lower, to name a few.”

On the balance sheet side of the equation, Baker and Streeter also re-ranked the capital structure ranking. Yee haw.

So if you are about to run out and purchase airline stocks, which stocks do the JP Morgan Dynamic Duo suggest you take a strong look at?

No surprises here.

Baker and Streeter said in their note that the legacy carriers they cover are all now “overweight,” they are “neutral” on the “discounters,” and “underweight” on the regionals.

With a few exceptions.

“LUV downgraded from N to UW, having outperformed as fuel made its ascent. PNCL maintained as an OW and RJET as N. AMR, CAL, and LCC upgraded from UW to OW; DAL and ALK from N to OW; NWA from UW to N. AAI and UAUA maintained at OW, JBLU at N.”

Traders are standing by now to take those buy orders.