* Shanghai down 0.6 pct led by small-caps; shrugs off PMI
* Hong Kong's Hang Seng holds technical support, up 0.4 pct
* Liquidity squeeze excuse for taking profits: analysts
* China manufacturing shows moderate pick up in July
* Eroding profit margins a concern: Macquarie (Updates to close)
by Vikram S.Subhedar and Farah Master
HONG KONG/SHANGHAI, Sept 1 (Reuters) - Shanghai stocks slipped on Wednesday as profit taking and concerns about shrinking profit margains offset a pick up in Chinese manufacturing activity that helped boost other Asian markets.
Hong Kong shares staged a small technical rebound, with the benchmark Hang Seng index <.HSI> rising 0.4 percent.
But the Shanghai Composite <.SSEC> fell 0.6 percent as small caps succumbed to profit taking after posting big gains in recent weeks. The CSI500 <.CSI500>, an index of small-cap mainland stocks, fell 1.3 percent.
Small-cap stocks have outperformed the broader market, with the CSI500 up over 32 percent since early July versus a 13 percent gain for the Shanghai Composite.
"The afternoon's fall shows investors trying to escape from small caps," said Chen Xingyu, analyst at Phillip Securities, adding that investors were using a recent liquidity squeeze as an excuse to pocket gains.
A huge supply of bonds and shares caused a temporary money market squeeze this week after large institutional demand for ICBC's convertible bond offering, while a slew of equity IPOs is set to freeze up 850 billion yuan in funds. [ID:nTOE68002I]
Zhang Gang, an analyst at Central Securities, said a spate of economic data from Beijing in the coming weeks may set a clearer direction for the index.
Despite its recent rebound, the Shanghai index is still down about 20 percent so far this year as government measures to curb property prices have made retail investors, who make up the bulk of the turnover on the mainland markets, increasingly wary.
HK HOLDS SUPPORT
Hong Kong's benchmark Hang Seng Index <.HSI> ended at 20,623.83 points, rising with other Asian markets, but gains were limited by the late slide in Shanghai.
Despite encouraging signs of stabilisation in a pair of manufacturing surveys in China, analysts cautioned that the robust domestic economy would have to battle the headwinds of soft external demand, especially from the United States. [ID:nTOE68001O]
"First-half earnings for Chinese companies were quite good but there's a push and pull going on," said Mark To, head of research at Wing Fung Financial in Hong Kong.
"Foreign investors are quite pessimistic given what's happening in foreign markets. And you can see from gold and U.S. Treasuries rising that appetite for equities is still weak."
While Chinese companies have reported generally strong interim profits, upward revisions to second-half earnings forecasts have remained muted, suggesting the outlook for the rest of 2010 remains cloudy.
One key concern is eroding operating margins in light of China's rising labour, energy, and land costs, analysts at Macquarie Research said in a note.
Operating margins fell year-over-year despite interim net profits growing over 40 percent on average for Chinese companies that have reported results so far, suggesting the results period was "deceptively mediocre", said Macquarie.
Foxconn International <2038.HK> shares fell 4.6 percent, extending their yearly losses to about 45 percent, as investors dumped shares on growing worries about its prospects.
Foxconn shares have slumped 11.5 percent in the past two sessions after the world's largest contract phone maker slipped deeper into the red in the first half as it fights rising costs, falling handset prices and wage pressures. [ID:nTOE67U03X]
BOC Hong Kong <2388.HK>, a key beneficiary of Beijing's efforts to gradually liberalise the yuan, rose 3.4 percent after data from the Hong Kong Monetary Authority showed a sharp rise in local yuan deposits in July. ($1=6.80 Yuan)