When I start emacs -Q, then do (create-fontset-from-fontset-spec
"-*-*-medium-*-*-*-12-*-*-*-*-*-fontset-startup"), then (make-frame
'((width . 81) (height . 50) (right-fringe . 11) (left-fringe . 10)
(font . fontset-startup))), this results, with the text I used in my OP,
in the "e" in the last occurrence of "testing" being in the *first*
column of the continued line, not the second, as you reported -- it
cannot be otherwise with that text and frame width 81 instead of 80, at
least if the font used has a fixed width (in my case the font is
-Adobe-Courier-Medium-R-Normal--12-120-75-75-M-70-ISO8859-1). But that
is the precisely position in which there is no "empty" line (nor
continuation arrows) after applying the display property, regardless of
whether the character is a space or not. Are you sure you didn't apply
the display property to the first column instead the second? Or are you
using a variable width font?