I think you fail to realise that The fight with the dragon never happened. Zack and Sephiroth may have fought a dragon yes, but Cloud didn't see it. And by this point, Zack has already proven that he's stronger than Angeal who was almost as strong as Sephiroth. That doesn't garuntee that Zack is stronger than Sephiroth, but it doesn't mean he wasn't either.
The fight with the dragon in FF7 is entirely to establish that compared to Cloud, Sephiroth ( or at least the way Cloud perceived Sephiroth) is a monster.

Lets not let this turn into a Zack vs Cloud arguement though.