Montreal, Canada

Asset price deflation has gained momentum since May across a swath of risk-based assets. Investors should heed the warnings and brace for a possible shakeout in world markets this summer or fall. Broader U.S. stock indexes are at the cusp of another major decline, if important support levels fail to hold this week.

Over the past three months, the price of copper has plunged 16%, aluminum has declined 18%, lead down 21% and nickel has fallen 27%. Spot benchmark iron ore has tanked 18% in the past three weeks and 36% from its peak in April.

Steel scrap prices, however, largely viewed as a leading indicator in the commodity space, have actually rallied lately. But that's an exception within the primary trend for many industrial metals, which have peaked in this cycle.

In May, we turned cautious on raw materials as signs of a correction began to materialize in the sector. Copper prices, the Baltic Dry Index, the price of TIPS and a renewed downturn in residential housing began to flash red. Combined with the huge rally in bond prices (or sharply lower yields), investors have begun to discount the possibility of a double-dip recession in 2011. Toss in the uncertainty looming regarding the expiration of the Bush tax cuts next year and investors and businesses have one less reason to be bullish and put money to work.

Two months into the correction for commodities, we remain bearish over the short-term as indicators continue to remain dogged by declining Chinese consumption, slack industrial global capacity and a slowdown underway in China and the United States. Europe is heading into outright deflation because of austerity measures while Japan remains stuck in a deflationary abyss.

In the United States, consumer prices hit their lowest levels since 1966 in June – another measure that's suggesting price pressures are threatening the recovery and corporate earnings. Companies must show revenue growth going forward; the cost-cutting blitz since last year is now exhausted.

Stocks remain in a correction. The S&P 500 Index has rallied off its early July trough when it was down 16.5% off its January best levels.

Despite a brief rally over the last two weeks, stocks are down 12.5% from their January highs as measured by the broader market. But small-caps, which led the post-March 2009 rally, are now bleeding hard since May; the Russell 2000 Index is now down 17.7% from its January high and bordering official bear market territory this month.

If asset prices continue to slide this summer, expect the Federal Reserve to announce another wave of quantitative easing. At this stage of the recovery, it's obvious that stimulus has drawn its course and real consumption is flagging. It's also true that broader monetary aggregates (M2) are in a freefall in the United States, Europe and Japan. Central banks are losing the war against deflation.