The next notch on this bull market's belt would be a new high in the

S&P 500

. With momentum in the index's favor, the milestone may well be on next week's horizon.

"It feels like there is some gravitational magnetic force pulling us to the old high," says John Roque, chief technical analyst at Natexis Bleichroeder.

The S&P 500 added 3 points Friday to close at 1505.62, edging closer to its all-time closing high of 1527.46 reached on March 24, 2000. The S&P 500's intraday high of 1552.87 also was reached that day.

Better-than-expected economic data and an earnings season that has surpassed expectations have propelled the

Dow Jones Industrial Average

and other indices to ever-rising highs over the past several weeks.

In the coming week, there's still no shortage of information -- including more earnings reports, retail sales, the producer price index and, most importantly, a

Federal Reserve

policy statement -- that could continue to move the markets.

But while these types of data are seen as the catalyst for the market's rise, the real and most powerful magnetic force at play is the shrinking supply of stock created by rampant merger-and-acquisition activity.

Replicating a week with stunning merger talk like last one's will be difficult, but the buyout bonanza's impact on the stock market will be felt for a long time. The headlines last week included

News Corp.'s

(NWS) - Get News Corporation Class B Report

out-of-the-blue bid at a 65% premium for

The Wall Street Journal

publisher

Dow Jones

(DJ)

, and a possible combination of tech giants

Microsoft

(MSFT) - Get Microsoft Corporation (MSFT) Report

and

Yahoo!

(YHOO)

.

While Dow Jones appears to have rebuffed News Corp.'s offer, and reports late Friday indicated that an outright Microsoft and Yahoo! combination is unlikely, the impact on the market was already done.

The Dow Jones offer in particular shows that the stock market is pricing stocks for control, rather than pricing stocks for ownership, says James Bianco, president of Bianco Research. The stock moved from the low $30s to the high $50s after News Corp.'s Rupert Murdoch offered $60 per share, and it has stayed near that level. The

rising tide brought many media stocks with it as investors figured that if the price for an "old media" business is this high, the sky's the limit for the sector.

The same was true for troubled automaker

TheStreet Recommends

General Motors

(GM) - Get General Motors Company (GM) Report

after billionaire Kirk Kerkorian took interest by buying a stake in 2005. It was the best-performing stock on the Dow last year.

Pricing stocks for control rather than ownership means the dogs can rally along with the genuinely good companies. "Give me a stock you can definitively say I should stay out of," challenges Bianco.

But pricing for control also means that the market's mentality shifts from the demand side to a supply side. Instead of the old faithful retail investor chasing stock market returns, the driver of prices becomes the dwindling supply of stock and the potential for further shrinkage.

Indeed, retail investors have not surged into U.S. stocks. AMG Data Services shows an outflow of $1.3 billion from domestic equities mutual funds (excluding exchange-traded funds) in the week ended May 2.

"Stocks would have been down Friday if it weren't for Microsoft and Yahoo!," says Marc Pado, chief market analyst at Cantor Fitzgerald. "It just brings up a huge plus in the market -- consolidation of stocks. You see less and less stock out there."

According to the Federal Reserve quarterly flow-of-funds data, the stock market's capitalization shrank by 2% in 2006, or by $400 billion. The first-quarter data come out in June, but given that this year's U.S. M&A activity is outpacing 2006 by about $200 million, the market could well shrink by more than another 2% by the end of 2007, says Bianco.

So, while a shrinking supply of stock will likely continue to mix with pricing for control next week, investors may find that some of the accompanying tailwinds are subsiding.

For instance, there is the daily ring of positive earnings surprises as the season winds down. While next week includes reports from the likes of

Walt Disney

(DIS) - Get Walt Disney Company Report

,

Tyco

(TYC)

and

Whole Foods

(WFMI)

, the majority of the S&P 500 already has released first-quarter results.

So far, against exceptionally low expectations for 3.3% growth in the first quarter, earnings have grown more than double that, at 8.1%. Companies that beat analysts' estimates have bested forecasts by 6.5% -- well above the historical average of 3.2%, according to Thomson Financial.

Traders also may be distracted by the

Federal Open Market Committee

meeting on Wednesday. The meeting always causes market jitters, even though this one is expected to almost certainly see the Fed keep the overnight borrowing rate at 5.25%.

The past week's economic data were supportive of the soft-landing story and of a Federal Reserve comfortably on hold. Manufacturing and services reported stronger activity. The Fed's preferred measure of core inflation dipped to 2.1% year over year, on its way toward the Fed's comfort zone of 1% to 2%; non-farm payrolls of 88,000 new jobs in April revealed some slack in labor costs and some labor market tightness.

That said, Ethan Harris, chief economist at Lehman Brothers, notes that while some inflation gauges have fallen, others remain troublesome. Labor costs are easing from multiyear highs, commodity pressures are still strong, inflation on imports is rising as inflation overseas grows, and the U.S. dollar has been in a downtrend since January.

"The idea that the Fed is going to drop its anti-inflation bias is wrong," says Harris. "They don't want to be declaring victory on inflation on a short-term wiggle in the data."

Lastly, stock market highs are common at this time of the year, says Pado, who believes in seasonal forces like "sell in May and go away."

While it does seem the path of least resistance is up to new highs for the S&P 500, there is technical resistance along the way there. The eight-month uptrend from last July's lows through February, point to resistance at 1511, he says. And if you line up the most recent uptrend from the S&P's March low through this week, he adds, the next resistance point is beyond a new high at 1535.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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