You won't use diagonals mode, you will use 8-way mode for all joysticks.  You will need to map Player 1 & 2 Joys so that UP actually equals UP+RIGHT and so forth, but it will still work perfectly because the 8 way zones are very even on the 49-ways.
It's going to take ALOT more programming than that to make this work properly.
As you have it, you will have either a 4-way stick (provided you use Q*Bert mode), or you will have HUGE deadspots on the original directions.
If UP=Up-Right, and LEFT=Up-Left, then the joystick will send no usable signal when only the Up switch is pressed.
I'm not completely sure that the following mapping will work because I haven't tested it, but it should.
It should also work on any 8-way stick--if it DOES work.
You need to map the inputs as follows:
NOTE: Red are MAME inputs, Green are Joystick inputs.
UP=(
Up NOT 
Up-Left) OR 
Up-Right OR (
Right NOT 
Right-Down)
LEFT=(
Left NOT 
Left-Down) OR 
Up-Left OR (
Up NOT 
Up-Right)
DOWN=(
Down NOT 
Down-Right) OR 
Down-Left OR (
Left NOT 
Left-Up)
RIGHT=(
Right NOT 
Right-Up) OR 
Down-Right OR (
Down NOT 
Down-Left)
Using this mapping, the original cardinal directions SHOULD send signals to 2 separate inputs (i.e. 
Up SHOULD trigger both the 
UP command, and the 
LEFT command).