You are doing nothing wrong. You will see that the HTML content of only those portions that need to be updated are sent. If your update panel is a very small portion of an entire page, then only the content of the update panel will be send. You will notice that the response is actually XML beginning with tags nameddelta.
You can look at the following KB article about achieving compression for aspx pages.
http://support.microsoft.com/?id=322603
and also this article
http://www.codeproject.com/aspnet/CompressibleHTTP20.asp
One other thing to make sure you do is to run the application with <compilation debug="false"/> set in your web.config file. If you have debugging on, then the Atlas JavaScript libraries will download on each browser request (which will slow things down). If you turn off debugging then they will be downloaded once and cached forever.
Hope this helps,
Scott
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