They mean h1 elements without a font-size specified in CSS (or style attribute) will be flagged as a warning. User agent styles can still override site styles if you want to set one.
> if I take some existing markup and blockquote it in some container, I'd expect the headings to shrink as they're now all sub-elements of some other section.
This logic only applied to the h1 element specifically, as it was an attempt to shoehorn some “clever” logic from the abandoned <h> tag proposed in a early draft of HTML5 (which was going to work the way you’d describe for headings at any level), on to the existing h1 element.
(Source: I used to follow the WHAT-WG mailing list closely during the HTML5 spec development process.)