The high-flying Hornets moved into third place in the Championship table through goals from Ikechi Anya and Nathaniel Chalobah - and McCarthy was impressed by the visitors' performance.
He said: "We were beaten by a very good side. They're as good as I've seen this season in this league. We did all right to keep it to two and worked very hard.
"But Watford were quality and sometimes you have to hold your hands up and admit you were beaten by the better side. Some people seem to have a problem doing that.
"I don't like it and I'm not happy that we were beaten, by they were the better side and deserved to win. I've got no complaints on that front whatsoever.
"We need another four or five wins (to avoid relegation) and I believe we've got the ability and team spirit to get them."
While McCarthy accepted that defeat was a logical outcome, he felt his side should have had a penalty for a foul on Lee Martin.
He added: "It was a penalty and on a night like tonight we needed the decision to go our way.
"You should have seen their bench gasp when the defender stuck his leg out and then breathe a sigh of relief when the penalty wasn't given."