MacOS System 7.5.x shipped on ~100MHz PowerPC chips with ~24MB of RAM, a bit higher in the later models. So the Watch most certainly has more processing power.
The real problem is emulating PPC -> ARM, which is a very slow process, and why the boot time is so long in the video.
For the record, my Performa 6116CD which shipped with 7.5 had a 60 MHZ PPC 601 and 8 MB RAM. It could run on significantly less than that as well - in fact I believe it ran as far back as on some 80s machines.
Not to mention the classic MacOS of that era had considerable amounts of code still written in 68k assembly, so a lot of what you're seeing is actually being emulated as 68k -> PPC -> ARM.
Processing power is not only frequency and memory. Different instruction sets might show drastically different performance. Processor cache might be higher on old computer (or might not, of course). Memory bandwidth or latency might differ too. I remember reading comparison between 1990 mainframe and current intel server. Mainframe has much higher memory bandwidth and performed much faster on tasks where processor cache was insufficient.
My understanding is that it is an A5 processor that is tuned for battery life, at the cost of performance. It all depends on the performance of the emulator, because OS 7 is not compiled for ARM.
I wonder why? After all, it's directly attached to a huge heatsink with a sophisticated liquid cooling setup that ensures it will stay at a comfortable 37C -- it will even do evaporative cooling when necessary, going so far as to replenish the liquid reservoir on its own.
http://www.cultofmac.com/320279/how-powerful-is-the-apple-wa...