I have a working stylesheet, but it uses modes when I think it could
be a bit slimmer and maybe more flexible.

The task is to create list containers (<ul>) around list elements in
a flat element tree. I tried to follow Jeni Tennison's advice for
constructing hierarchies <http://jenitennison.com/xslt/hierarchies-
out.xml> and also evaluated xsl:for-each-group, but the latter seems
not to work very well for a stylesheet in push mode (no changes to
the element order).

To correctly group the <li1>s and <li2>s (even in the third case) in
this example I successfully used the XSL below. I found no good
enough example in the FAQs, so I dare to ask, whether there is a more
elegant solution. (I simplified the case, in reality there are
multiple elements that are either level 1 or level 2 list elements,
and I do not use starts-with() to detect element names.)

<?xml version="1.0" encoding="UTF-8"?>
<levels>
<p/>
<li1>1</li1>
<li1>2</li1>
<li1>3</li1>
<li1>4</li1>
<p/>
<li1>5</li1>
<li1>6</li1>
<li2>7.1</li2>
<li2>7.2</li2>
<p/>
<li2>8.1</li2>
<li2>8.2</li2>
<li1>9</li1>
<li1>10</li1>
<p/>
</levels>

<xsl:stylesheet version="2.0"
                xmlns:xsl="http://www.w3.org/1999/XSL/Transform">
<xsl:strip-space elements="*"/>
<xsl:output method="xml" indent="yes" />

<!-- Root element -->
<xsl:template match="levels">
  <xsl:copy>
    <xsl:apply-templates />
  </xsl:copy>
</xsl:template>

<!-- Keys to identify list elements after first element -->
<xsl:key name="list12-other"
  match="*[self::*[starts-with(name(), 'li')]
    and preceding-sibling::*[1][starts-with(name(), 'li')]]"
  use="generate-id(
    preceding-sibling::*[
      starts-with(name(), 'li')
      and not(preceding-sibling::*[1][starts-with(name(), 'li')])
    ][1])" />

<xsl:key name="list2-other"
  match="li2[preceding-sibling::*[1][self::li2]]"
  use="generate-id(
    preceding-sibling::li2[
      not(preceding-sibling::*[1][self::li2])
    ][1])" />

<!-- List 1 Container-->
<xsl:template match="*[starts-with(name(), 'li')
  and not(preceding-sibling::*[1][starts-with(name(), 'li')])]"
priority="1">
  <ul level="1">
    <xsl:apply-templates mode="list1"
      select=". | key('list12-other', generate-id())" />
  </ul>
</xsl:template>
<!-- List 1 elements -->
<xsl:template match="li1" mode="list1">
  <li tag="{name()}" pos="{position()}">
    <xsl:apply-templates />
  </li>
</xsl:template>

<!-- or List 2 Container-->
<xsl:template match="li2[not(preceding-sibling::*[1][self::li2])]"
  mode="list1" priority="1">
  <ul level="2">
    <xsl:apply-templates mode="list2"
      select=". | key('list2-other', generate-id())" />
  </ul>
</xsl:template>
<!-- List 2 elements -->
<xsl:template match="li2" mode="list2">
  <li tag="{name()}" pos="{position()}">
    <xsl:apply-templates />
  </li>
</xsl:template>

<!-- skip list elements when matched outside list -->
<xsl:template match="li2" mode="list1"/>
<xsl:template match="*[starts-with(name(), 'li')]"/>

<!-- all other nodes -->
<xsl:template match="node()">
  <xsl:copy>
    <xsl:apply-templates />
  </xsl:copy>
</xsl:template>